Today we are going to look at Tsaker Chemical Group Limited (HKG:1986) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Tsaker Chemical Group:

0.18 = CN¥199m ÷ (CN¥2.3b – CN¥709m) (Based on the trailing twelve months to June 2018.)

Therefore, Tsaker Chemical Group has an ROCE of 18%.

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Is Tsaker Chemical Group’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Tsaker Chemical Group’s ROCE appears to be substantially greater than the 11% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Tsaker Chemical Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Tsaker Chemical Group’s current ROCE of 18% is lower than 3 years ago, when the company reported a 60% ROCE. So investors might consider if it has had issues recently.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Tsaker Chemical Group.

What Are Current Liabilities, And How Do They Affect Tsaker Chemical Group’s ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Tsaker Chemical Group has total assets of CN¥2.3b and current liabilities of CN¥709m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Tsaker Chemical Group has a middling amount of current liabilities, increasing its ROCE somewhat.

Our Take On Tsaker Chemical Group’s ROCE

Tsaker Chemical Group’s ROCE does look good, but the level of current liabilities also contribute to that. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Tsaker Chemical Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.