Here's What Novacon Technology Group Limited's (HKG:8635) ROCE Can Tell Us
Today we'll look at Novacon Technology Group Limited (HKG:8635) 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
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. In brief, it is a useful tool, but it is not without drawbacks. 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 Novacon Technology Group:
0.14 = HK$14m ÷ (HK$111m - HK$16m) (Based on the trailing twelve months to December 2019.)
Therefore, Novacon Technology Group has an ROCE of 14%.
See our latest analysis for Novacon Technology Group
Does Novacon Technology Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Novacon Technology Group's ROCE is meaningfully better than the 6.5% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Novacon Technology Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how Novacon Technology Group's ROCE compares to its industry, and you can click it to see more detail on its 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Novacon Technology Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Novacon Technology Group's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.
Novacon Technology Group has total assets of HK$111m and current liabilities of HK$16m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Novacon Technology Group's ROCE
With that in mind, Novacon Technology Group's ROCE appears pretty good. Novacon Technology Group 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.
I will like Novacon Technology 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.
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