Here's What Tiangong International Company Limited's (HKG:826) ROCE Can Tell Us

Today we'll evaluate Tiangong International Company Limited (HKG:826) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from 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. 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 Tiangong International:

0.097 = CN¥577m ÷ (CN¥10b - CN¥4.2b) (Based on the trailing twelve months to December 2019.)

Therefore, Tiangong International has an ROCE of 9.7%.

View our latest analysis for Tiangong International

Is Tiangong International's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Tiangong International's ROCE is meaningfully higher than the 7.1% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Tiangong International's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

We can see that, Tiangong International currently has an ROCE of 9.7% compared to its ROCE 3 years ago, which was 5.4%. This makes us wonder if the company is improving. You can see in the image below how Tiangong International's ROCE compares to its industry. Click to see more on past growth.

When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. Given the industry it operates in, Tiangong International could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Tiangong International's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Tiangong International has total assets of CN¥10b and current liabilities of CN¥4.2b. Therefore its current liabilities are equivalent to approximately 42% of its total assets. With this level of current liabilities, Tiangong International's ROCE is boosted somewhat.

Our Take On Tiangong International's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Tiangong International out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like Tiangong International 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.