Today we'll look at EVA Precision Industrial Holdings Limited (HKG:838) and reflect on its potential as an investment. 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. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 EVA Precision Industrial Holdings:

0.045 = HK$144m ÷ (HK$5.7b - HK$2.5b) (Based on the trailing twelve months to December 2018.)

Therefore, EVA Precision Industrial Holdings has an ROCE of 4.5%.

Check out our latest analysis for EVA Precision Industrial Holdings

Does EVA Precision Industrial Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, EVA Precision Industrial Holdings's ROCE appears to be significantly below the 9.9% average in the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how EVA Precision Industrial Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

EVA Precision Industrial Holdings's current ROCE of 4.5% is lower than 3 years ago, when the company reported a 7.8% ROCE. Therefore we wonder if the company is facing new headwinds.

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. You can check if EVA Precision Industrial Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do EVA Precision Industrial Holdings's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.

EVA Precision Industrial Holdings has total liabilities of HK$2.5b and total assets of HK$5.7b. As a result, its current liabilities are equal to approximately 44% of its total assets. With a medium level of current liabilities boosting the ROCE a little, EVA Precision Industrial Holdings's low ROCE is unappealing.

Our Take On EVA Precision Industrial Holdings's ROCE

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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.