Today we'll look at Nanfang Communication Holdings Limited (HKG:1617) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

What is 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. All else being equal, a better business will have a higher ROCE. 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 Nanfang Communication Holdings:

0.046 = CN¥38m ÷ (CN¥1.3b - CN¥498m) (Based on the trailing twelve months to December 2019.)

Therefore, Nanfang Communication Holdings has an ROCE of 4.6%.

Check out our latest analysis for Nanfang Communication Holdings

Does Nanfang Communication Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Nanfang Communication Holdings's ROCE appears to be significantly below the 7.4% average in the Communications industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Nanfang Communication Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Nanfang Communication Holdings's current ROCE of 4.6% is lower than 3 years ago, when the company reported a 17% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Nanfang Communication Holdings's past growth compares to other companies.

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. ROCE is only a point-in-time measure. If Nanfang Communication Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Nanfang Communication Holdings's Current Liabilities Skew 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 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.

Nanfang Communication Holdings has current liabilities of CN¥498m and total assets of CN¥1.3b. As a result, its current liabilities are equal to approximately 37% of its total assets. Nanfang Communication Holdings has a medium level of current liabilities, which would boost its ROCE somewhat.

The Bottom Line On Nanfang Communication Holdings's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.