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Today we'll look at Niche-Tech Group Limited (HKG:8490) and reflect on its potential as an investment. 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. Finally, we'll look at how its current liabilities affect 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. 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'.
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 Niche-Tech Group:
0.042 = HK$10m ÷ (HK$275m - HK$29m) (Based on the trailing twelve months to March 2019.)
Therefore, Niche-Tech Group has an ROCE of 4.2%.
View our latest analysis for Niche-Tech Group
Does Niche-Tech Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Niche-Tech Group's ROCE is meaningfully below the Semiconductor industry average of 5.8%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Niche-Tech Group 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.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Niche-Tech Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Niche-Tech Group's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.