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Today we'll look at Wai Kee Holdings Limited (HKG:610) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding 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. All else being equal, a better business will have a higher ROCE. 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 Wai Kee Holdings:

0.038 = HK$352m ÷ (HK$13b - HK$3.5b) (Based on the trailing twelve months to December 2018.)

So, Wai Kee Holdings has an ROCE of 3.8%.

View our latest analysis for Wai Kee Holdings

Is Wai Kee Holdings's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Wai Kee Holdings's ROCE appears to be significantly below the 13% average in the Construction industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Wai Kee Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

Our data shows that Wai Kee Holdings currently has an ROCE of 3.8%, compared to its ROCE of 1.3% 3 years ago. This makes us think the business might be improving. You can see in the image below how Wai Kee Holdings's ROCE compares to its industry. Click to see more on past growth.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Wai Kee Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Wai Kee Holdings's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Wai Kee Holdings has total assets of HK$13b and current liabilities of HK$3.5b. As a result, its current liabilities are equal to approximately 27% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Wai Kee Holdings's ROCE

While that is good to see, Wai Kee Holdings has a low ROCE and does not look attractive in this analysis. 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.