Today we'll evaluate China Yuchai International Limited (NYSE:CYD) 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.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. Ultimately, it is a useful but imperfect metric. 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 China Yuchai International:

0.095 = CN¥1.1b ÷ (CN¥22b - CN¥9.6b) (Based on the trailing twelve months to December 2019.)

Therefore, China Yuchai International has an ROCE of 9.5%.

See our latest analysis for China Yuchai International

Is China Yuchai International's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that China Yuchai International's ROCE is fairly close to the Machinery industry average of 11%. Setting aside the industry comparison for now, China Yuchai International's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

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

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How China Yuchai International's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

China Yuchai International has total assets of CN¥22b and current liabilities of CN¥9.6b. Therefore its current liabilities are equivalent to approximately 44% of its total assets. China Yuchai International has a medium level of current liabilities, which would boost its ROCE somewhat.

What We Can Learn From China Yuchai International's ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like China Yuchai International better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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. Thank you for reading.