Today we'll look at Dream International Limited (HKG:1126) and reflect on its potential as an investment. 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. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. 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?

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 Dream International:

0.20 = HK$401m ÷ (HK$2.8b - HK$795m) (Based on the trailing twelve months to June 2019.)

Therefore, Dream International has an ROCE of 20%.

See our latest analysis for Dream International

Does Dream International Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, Dream International's ROCE is meaningfully higher than the 8.4% average in the Leisure industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Dream International compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can click on the image below to see (in greater detail) how Dream International's past growth compares to other companies.

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Dream International.

Do Dream International's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.

Dream International has current liabilities of HK$795m and total assets of HK$2.8b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Dream International's ROCE

Overall, Dream International has a decent ROCE and could be worthy of further research. Dream International 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.

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

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.