Today we'll evaluate Shineroad International Holdings Limited (HKG:1587) 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.

Firstly, we'll go over how we 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.

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

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?

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 Shineroad International Holdings:

0.13 = CN¥37m ÷ (CN¥335m - CN¥47m) (Based on the trailing twelve months to June 2019.)

So, Shineroad International Holdings has an ROCE of 13%.

See our latest analysis for Shineroad International Holdings

Is Shineroad International Holdings's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Shineroad International Holdings's ROCE appears to be substantially greater than the 10% average in the Consumer Retailing industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Shineroad International Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

We can see that, Shineroad International Holdings currently has an ROCE of 13%, less than the 40% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Shineroad International Holdings's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if Shineroad International Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Shineroad International Holdings's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Shineroad International Holdings has total assets of CN¥335m and current liabilities of CN¥47m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Shineroad International Holdings's ROCE

With that in mind, Shineroad International Holdings's ROCE appears pretty good. There might be better investments than Shineroad International 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.