Today we'll evaluate Pizu Group Holdings Limited (HKG:8053) 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

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

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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?

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 Pizu Group Holdings:

0.43 = CN¥380m ÷ (CN¥1.4b - CN¥517m) (Based on the trailing twelve months to June 2019.)

Therefore, Pizu Group Holdings has an ROCE of 44%.

View our latest analysis for Pizu Group Holdings

Does Pizu Group Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, Pizu Group Holdings's ROCE is meaningfully higher than the 6.1% average in the Trade Distributors industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Pizu Group Holdings's ROCE currently appears to be excellent.

The image below shows how Pizu Group Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

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 Pizu Group Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Pizu Group Holdings's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.