Today we'll evaluate China Sunsine Chemical Holdings Ltd. (SGX:CH8) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

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 China Sunsine Chemical Holdings:

0.24 = CN¥596m ÷ (CN¥2.8b - CN¥366m) (Based on the trailing twelve months to June 2019.)

Therefore, China Sunsine Chemical Holdings has an ROCE of 24%.

Check out our latest analysis for China Sunsine Chemical Holdings

Does China Sunsine Chemical Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. China Sunsine Chemical Holdings's ROCE appears to be substantially greater than the 2.5% average in the Chemicals 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. Putting aside its position relative to its industry for now, in absolute terms, China Sunsine Chemical Holdings's ROCE is currently very good.

The image below shows how China Sunsine Chemical Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Sunsine Chemical Holdings.

Do China Sunsine Chemical Holdings'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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

China Sunsine Chemical Holdings has total assets of CN¥2.8b and current liabilities of CN¥366m. As a result, its current liabilities are equal to approximately 13% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

What We Can Learn From China Sunsine Chemical Holdings's ROCE

This is good to see, and with such a high ROCE, China Sunsine Chemical Holdings may be worth a closer look. China Sunsine Chemical Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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.