Today we are going to look at Weichai Power Co., Ltd. (HKG:2338) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. Overall, it is a valuable metric that has its flaws. 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'.

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

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

Or for Weichai Power:

0.11 = CN¥13b ÷ (CN¥205b - CN¥89b) (Based on the trailing twelve months to December 2018.)

Therefore, Weichai Power has an ROCE of 11%.

See our latest analysis for Weichai Power

Does Weichai Power Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Weichai Power's ROCE appears to be around the 10% average of the Machinery industry. Separate from Weichai Power's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Our data shows that Weichai Power currently has an ROCE of 11%, compared to its ROCE of 4.1% 3 years ago. This makes us wonder if the company is improving.

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 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 Weichai Power.

What Are Current Liabilities, And How Do They Affect Weichai Power's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.