Today we’ll evaluate Valuetronics Holdings Limited (SGX:BN2) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the 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. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Valuetronics Holdings:

0.20 = HK$217m ÷ (HK$2.0b – HK$932m) (Based on the trailing twelve months to September 2018.)

Therefore, Valuetronics Holdings has an ROCE of 20%.

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Is Valuetronics Holdings’s ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Valuetronics Holdings’s ROCE is meaningfully higher than the 9.1% average in the Electronic industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Valuetronics Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Valuetronics Holdings’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Valuetronics Holdings has total liabilities of HK$932m and total assets of HK$2.0b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. With this level of current liabilities, Valuetronics Holdings’s ROCE is boosted somewhat.

The Bottom Line On Valuetronics Holdings’s ROCE

Valuetronics Holdings’s ROCE does look good, but the level of current liabilities also contribute to that. But note: Valuetronics Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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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.