Today we'll look at KFM Kingdom Holdings Limited (HKG:3816) 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. Then we'll compare its ROCE 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

How Do You Calculate Return On Capital Employed?

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 KFM Kingdom Holdings:

0.10 = HK$52m ÷ (HK$1.1b - HK$621m) (Based on the trailing twelve months to September 2018.)

So, KFM Kingdom Holdings has an ROCE of 10%.

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Does KFM Kingdom Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, KFM Kingdom Holdings's ROCE appears to be around the 10% average of the Machinery industry. Regardless of where KFM Kingdom Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

As we can see, KFM Kingdom Holdings currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 0.2%. This makes us think the business might be improving.

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. ROCE is, after all, simply a snap shot of a single year. If KFM Kingdom Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

KFM Kingdom Holdings's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

KFM Kingdom Holdings has total assets of HK$1.1b and current liabilities of HK$621m. Therefore its current liabilities are equivalent to approximately 55% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.

Our Take On KFM Kingdom Holdings's ROCE

While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. There might be better investments than KFM Kingdom Holdings 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.