Today we are going to look at Virscend Education Company Limited (HKG:1565) to see whether it might be an attractive investment prospect. 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. Then we’ll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?

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 Virscend Education:

0.12 = CN¥369m ÷ (CN¥4.6b – CN¥1.2b) (Based on the trailing twelve months to June 2018.)

So, Virscend Education has an ROCE of 12%.

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Is Virscend Education’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. It appears that Virscend Education’s ROCE is fairly close to the Consumer Services industry average of 13%. Regardless of where Virscend Education sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Virscend Education.

Virscend Education’s Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Virscend Education has total liabilities of CN¥1.2b and total assets of CN¥4.6b. As a result, its current liabilities are equal to approximately 27% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From Virscend Education’s ROCE

With that in mind, Virscend Education’s ROCE appears pretty good. You might be able to find a better buy than Virscend Education. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.