Today we'll evaluate Clifford Modern Living Holdings Limited (HKG:3686) 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. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is 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. 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?

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 Clifford Modern Living Holdings:

0.27 = CN¥100m ÷ (CN¥538m - CN¥163m) (Based on the trailing twelve months to June 2019.)

So, Clifford Modern Living Holdings has an ROCE of 27%.

See our latest analysis for Clifford Modern Living Holdings

Is Clifford Modern Living Holdings's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Clifford Modern Living Holdings's ROCE is meaningfully higher than the 3.3% average in the Industrials 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. Setting aside the comparison to its industry for a moment, Clifford Modern Living Holdings's ROCE in absolute terms currently looks quite high.

The image below shows how Clifford Modern Living 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. How cyclical is Clifford Modern Living Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Clifford Modern Living Holdings's Current Liabilities And Their Impact On 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Clifford Modern Living Holdings has current liabilities of CN¥163m and total assets of CN¥538m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Clifford Modern Living Holdings has a medium level of current liabilities, boosting its ROCE somewhat.

What We Can Learn From Clifford Modern Living Holdings's ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. Clifford Modern Living Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.