Today we'll evaluate Pipeline Engineering Holding Limited (HKG:1865) 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

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

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'

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 Pipeline Engineering Holding:

0.13 = S$5.1m ÷ (S$50m - S$12m) (Based on the trailing twelve months to March 2019.)

Therefore, Pipeline Engineering Holding has an ROCE of 13%.

Check out our latest analysis for Pipeline Engineering Holding

Is Pipeline Engineering Holding's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Pipeline Engineering Holding's ROCE appears to be around the 13% average of the Construction industry. Regardless of where Pipeline Engineering Holding sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Pipeline Engineering Holding's current ROCE of 13% is lower than its ROCE in the past, which was 27%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Pipeline Engineering Holding's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. You can check if Pipeline Engineering Holding has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Pipeline Engineering Holding'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Pipeline Engineering Holding has total liabilities of S$12m and total assets of S$50m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From Pipeline Engineering Holding's ROCE

Overall, Pipeline Engineering Holding has a decent ROCE and could be worthy of further research. There might be better investments than Pipeline Engineering Holding 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 Pipeline Engineering Holding better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.