Today we are going to look at Sinosoft Technology Group Limited (HKG:1297) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

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 Sinosoft Technology Group:

0.22 = CN¥325m ÷ (CN¥1.8b - CN¥265m) (Based on the trailing twelve months to June 2019.)

Therefore, Sinosoft Technology Group has an ROCE of 22%.

See our latest analysis for Sinosoft Technology Group

Does Sinosoft Technology Group Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Sinosoft Technology Group's ROCE is meaningfully higher than the 9.4% average in the Software 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. Setting aside the comparison to its industry for a moment, Sinosoft Technology Group's ROCE in absolute terms currently looks quite high.

You can click on the image below to see (in greater detail) how Sinosoft Technology Group's past growth compares to other companies.

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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Sinosoft Technology Group's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Sinosoft Technology Group has total assets of CN¥1.8b and current liabilities of CN¥265m. As a result, its current liabilities are equal to approximately 15% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

What We Can Learn From Sinosoft Technology Group's ROCE

This is good to see, and with such a high ROCE, Sinosoft Technology Group may be worth a closer look. Sinosoft Technology Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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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.

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