Today we'll evaluate Zhejiang Cangnan Instrument Group Company Limited (HKG:1743) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

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 Zhejiang Cangnan Instrument Group:

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

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

View our latest analysis for Zhejiang Cangnan Instrument Group

Does Zhejiang Cangnan Instrument Group Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Zhejiang Cangnan Instrument Group's ROCE is meaningfully better than the 10% average in the Electronic industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Zhejiang Cangnan Instrument Group's ROCE currently appears to be excellent.

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

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. You can check if Zhejiang Cangnan Instrument Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Zhejiang Cangnan Instrument Group's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. 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. A minimal amount of current liabilities limits the impact on ROCE.

The Bottom Line On Zhejiang Cangnan Instrument Group's ROCE

Low current liabilities and high ROCE is a good combination, making Zhejiang Cangnan Instrument Group look quite interesting. There might be better investments than Zhejiang Cangnan Instrument Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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.

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.

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