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Today we'll evaluate High Fashion International Limited (HKG:608) 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 of all, we'll work out how to 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.

Return On Capital Employed (ROCE): What is it?

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. 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 High Fashion International:

0.0038 = HK$13m ÷ (HK$5.1b - HK$1.6b) (Based on the trailing twelve months to December 2018.)

Therefore, High Fashion International has an ROCE of 0.4%.

View our latest analysis for High Fashion International

Is High Fashion International's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, High Fashion International's ROCE appears to be significantly below the 11% average in the Luxury industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside High Fashion International's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

We can see that , High Fashion International currently has an ROCE of 0.4%, less than the 0.9% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how High Fashion International's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 only a point-in-time measure. You can check if High Fashion International has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How High Fashion International's Current Liabilities Impact 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 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.

High Fashion International has total assets of HK$5.1b and current liabilities of HK$1.6b. As a result, its current liabilities are equal to approximately 32% of its total assets. With a medium level of current liabilities boosting the ROCE a little, High Fashion International's low ROCE is unappealing.

The Bottom Line On High Fashion International's ROCE

There are likely better investments out there. 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 High Fashion International better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.