Today we'll look at Yuan Heng Gas Holdings Limited (HKG:332) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

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

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?

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 Yuan Heng Gas Holdings:

0.069 = CN¥108m ÷ (CN¥4.2b - CN¥2.7b) (Based on the trailing twelve months to September 2019.)

So, Yuan Heng Gas Holdings has an ROCE of 6.9%.

Check out our latest analysis for Yuan Heng Gas Holdings

Is Yuan Heng Gas Holdings's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Yuan Heng Gas Holdings's ROCE appears to be around the 7.6% average of the Oil and Gas industry. Aside from the industry comparison, Yuan Heng Gas Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Our data shows that Yuan Heng Gas Holdings currently has an ROCE of 6.9%, compared to its ROCE of 0.08% 3 years ago. This makes us think the business might be improving. You can see in the image below how Yuan Heng Gas Holdings's ROCE compares to its industry. Click to see more on past growth.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. We note Yuan Heng Gas Holdings could be considered a cyclical business. If Yuan Heng Gas Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Yuan Heng Gas Holdings's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Yuan Heng Gas Holdings has total assets of CN¥4.2b and current liabilities of CN¥2.7b. As a result, its current liabilities are equal to approximately 63% of its total assets. Yuan Heng Gas Holdings's current liabilities are fairly high, making its ROCE look better than otherwise.

The Bottom Line On Yuan Heng Gas Holdings's ROCE

Even so, the company reports a mediocre ROCE, and there may be better investments out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.