Today we'll look at Prinx Chengshan (Cayman) Holding Limited (HKG:1809) 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

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

ROCE measures the amount of pre-tax profits a company can generate from the 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. 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?

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 Prinx Chengshan (Cayman) Holding:

0.16 = CN¥524m ÷ (CN¥5.4b - CN¥2.2b) (Based on the trailing twelve months to June 2019.)

So, Prinx Chengshan (Cayman) Holding has an ROCE of 16%.

View our latest analysis for Prinx Chengshan (Cayman) Holding

Does Prinx Chengshan (Cayman) Holding Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Prinx Chengshan (Cayman) Holding's ROCE is meaningfully higher than the 11% average in the Auto Components industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Prinx Chengshan (Cayman) Holding compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Prinx Chengshan (Cayman) Holding's current ROCE of 16% is lower than 3 years ago, when the company reported a 27% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Prinx Chengshan (Cayman) Holding's ROCE compares to its industry. Click to see more on past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Prinx Chengshan (Cayman) Holding.

Do Prinx Chengshan (Cayman) Holding'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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Prinx Chengshan (Cayman) Holding has total assets of CN¥5.4b and current liabilities of CN¥2.2b. As a result, its current liabilities are equal to approximately 40% of its total assets. Prinx Chengshan (Cayman) Holding has a medium level of current liabilities, which would boost the ROCE.

What We Can Learn From Prinx Chengshan (Cayman) Holding's ROCE

Prinx Chengshan (Cayman) Holding's ROCE does look good, but the level of current liabilities also contribute to that. Prinx Chengshan (Cayman) Holding 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.

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.