Today we'll look at EVA Precision Industrial Holdings Limited (HKG:838) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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?

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 EVA Precision Industrial Holdings:

0.045 = HK$144m ÷ (HK$5.7b - HK$2.5b) (Based on the trailing twelve months to December 2018.)

Therefore, EVA Precision Industrial Holdings has an ROCE of 4.5%.

Check out our latest analysis for EVA Precision Industrial Holdings

Does EVA Precision Industrial Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, EVA Precision Industrial Holdings's ROCE appears to be significantly below the 9.9% average in the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how EVA Precision Industrial Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

EVA Precision Industrial Holdings's current ROCE of 4.5% is lower than 3 years ago, when the company reported a 7.8% ROCE. Therefore we wonder if the company is facing new headwinds.

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. ROCE is, after all, simply a snap shot of a single year. You can check if EVA Precision Industrial Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.