Today we'll evaluate Zhejiang Cangnan Instrument Group Company Limited (HKG:1743) to determine whether it could have potential as an investment idea. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

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

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Zhejiang Cangnan Instrument Group:

0.26 = CN¥255m ÷ (CN¥1.3b - CN¥376m) (Based on the trailing twelve months to June 2019.)

Therefore, Zhejiang Cangnan Instrument Group has an ROCE of 26%.

Check out our latest analysis for Zhejiang Cangnan Instrument Group

Does Zhejiang Cangnan Instrument Group Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Zhejiang Cangnan Instrument Group's ROCE is meaningfully higher than the 10% average in the Electronic industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Zhejiang Cangnan Instrument Group's ROCE currently appears to be excellent.

You can click on the image below to see (in greater detail) how Zhejiang Cangnan Instrument Group's past growth compares to other companies.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Zhejiang Cangnan Instrument Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Zhejiang Cangnan Instrument Group's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Zhejiang Cangnan Instrument Group has total assets of CN¥1.3b and current liabilities of CN¥376m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.

What We Can Learn From Zhejiang Cangnan Instrument Group's ROCE

This is good to see, and with such a high ROCE, Zhejiang Cangnan Instrument Group may be worth a closer look. Zhejiang Cangnan Instrument Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Zhejiang Cangnan Instrument Group 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.