Today we'll evaluate Hebei Yichen Industrial Group Corporation Limited (HKG:1596) to determine whether it could have potential as an investment idea. 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.

First, 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.

Understanding 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?

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 Hebei Yichen Industrial Group:

0.084 = CN¥173m ÷ (CN¥2.6b - CN¥549m) (Based on the trailing twelve months to June 2019.)

Therefore, Hebei Yichen Industrial Group has an ROCE of 8.4%.

See our latest analysis for Hebei Yichen Industrial Group

Does Hebei Yichen Industrial Group Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Hebei Yichen Industrial Group's ROCE appears to be significantly below the 11% average in the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Hebei Yichen Industrial Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Hebei Yichen Industrial Group's current ROCE of 8.4% is lower than 3 years ago, when the company reported a 34% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Hebei Yichen Industrial Group'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. You can check if Hebei Yichen Industrial Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Hebei Yichen Industrial Group's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Hebei Yichen Industrial Group has total assets of CN¥2.6b and current liabilities of CN¥549m. As a result, its current liabilities are equal to approximately 21% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Hebei Yichen Industrial Group's ROCE

If Hebei Yichen Industrial Group continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Hebei Yichen Industrial Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Hebei Yichen Industrial 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.

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.