Today we are going to look at Top Education Group Ltd (HKG:1752) to see whether it might be an attractive investment prospect. 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. 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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'.

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 Top Education Group:

0.15 = AU$7.8m ÷ (AU$60m - AU$7.7m) (Based on the trailing twelve months to December 2018.)

Therefore, Top Education Group has an ROCE of 15%.

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

See our latest analysis for Top Education Group

Does Top Education Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Top Education Group's ROCE is meaningfully better than the 11% average in the Consumer Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Top Education Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

As we can see, Top Education Group currently has an ROCE of 15%, less than the 43% it reported 3 years ago. So investors might consider if it has had issues recently.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. How cyclical is Top Education Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do Top Education Group'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Top Education Group has total assets of AU$60m and current liabilities of AU$7.7m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

The Bottom Line On Top Education Group's ROCE

With that in mind, Top Education Group's ROCE appears pretty good. There might be better investments than Top Education Group 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.