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Today we'll evaluate China Aerospace International Holdings Limited (HKG:31) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. 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.

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. Generally speaking a higher ROCE is better. 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.'

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for China Aerospace International Holdings:

0.031 = HK$409m ÷ (HK$14b - HK$1.2b) (Based on the trailing twelve months to December 2018.)

Therefore, China Aerospace International Holdings has an ROCE of 3.1%.

Check out our latest analysis for China Aerospace International Holdings

Does China Aerospace International Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In this analysis, China Aerospace International Holdings's ROCE appears meaningfully below the 10% average reported by the Electronic industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside China Aerospace International Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

In our analysis, China Aerospace International Holdings's ROCE appears to be 3.1%, compared to 3 years ago, when its ROCE was 1.5%. This makes us think the business might be improving.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is China Aerospace International Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How China Aerospace International Holdings's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

China Aerospace International Holdings has total assets of HK$14b and current liabilities of HK$1.2b. Therefore its current liabilities are equivalent to approximately 8.7% of its total assets. China Aerospace International Holdings has very few current liabilities, which have a minimal effect on its already low ROCE.

Our Take On China Aerospace International Holdings's ROCE

Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better buy than China Aerospace International Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.