Today we'll look at Kwoon Chung Bus Holdings Limited (HKG:306) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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'.

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 Kwoon Chung Bus Holdings:

0.071 = HK$233m ÷ (HK$5.3b - HK$2.1b) (Based on the trailing twelve months to September 2019.)

So, Kwoon Chung Bus Holdings has an ROCE of 7.1%.

Check out our latest analysis for Kwoon Chung Bus Holdings

Is Kwoon Chung Bus Holdings's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Kwoon Chung Bus Holdings's ROCE appears to be substantially greater than the 5.0% average in the Transportation 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. Separate from how Kwoon Chung Bus Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

Kwoon Chung Bus Holdings's current ROCE of 7.1% is lower than 3 years ago, when the company reported a 11% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Kwoon Chung Bus Holdings's ROCE compares to its industry. Click to see more on past growth.

It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Kwoon Chung Bus Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Kwoon Chung Bus Holdings's Current Liabilities Impact 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.

Kwoon Chung Bus Holdings has total assets of HK$5.3b and current liabilities of HK$2.1b. Therefore its current liabilities are equivalent to approximately 39% of its total assets. Kwoon Chung Bus Holdings's ROCE is improved somewhat by its moderate amount of current liabilities.

What We Can Learn From Kwoon Chung Bus Holdings's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Kwoon Chung Bus Holdings 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.

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