Today we are going to look at Modern Beauty Salon Holdings Limited (HKG:919) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

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. 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 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. 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 Modern Beauty Salon Holdings:

0.19 = HK$43m ÷ (HK$655m - HK$432m) (Based on the trailing twelve months to September 2019.)

So, Modern Beauty Salon Holdings has an ROCE of 19%.

See our latest analysis for Modern Beauty Salon Holdings

Is Modern Beauty Salon Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Modern Beauty Salon Holdings's ROCE is meaningfully better than the 11% average in the Consumer Services industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Modern Beauty Salon Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

We can see that, Modern Beauty Salon Holdings currently has an ROCE of 19%, less than the 27% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Modern Beauty Salon Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Modern Beauty Salon Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Modern Beauty Salon Holdings's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Modern Beauty Salon Holdings has total assets of HK$655m and current liabilities of HK$432m. As a result, its current liabilities are equal to approximately 66% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.

The Bottom Line On Modern Beauty Salon Holdings's ROCE

This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. There might be better investments than Modern Beauty Salon 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.

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.