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Today we’ll look at Wison Engineering Services Co. Ltd. (HKG:2236) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. 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 Wison Engineering Services:

0.042 = CN¥178m ÷ (CN¥6.2b – CN¥3.9b) (Based on the trailing twelve months to June 2018.)

Therefore, Wison Engineering Services has an ROCE of 4.2%.

See our latest analysis for Wison Engineering Services

Does Wison Engineering Services Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Wison Engineering Services’s ROCE appears to be significantly below the 6.3% average in the Energy Services 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 Wison Engineering Services 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.

Wison Engineering Services’s current ROCE of 4.2% is lower than its ROCE in the past, which was 31%, 3 years ago. So investors might consider if it has had issues recently.

When considering this metric, keep in mind that it is backwards looking, and 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. We note Wison Engineering Services could be considered a cyclical business. If Wison Engineering Services is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Wison Engineering Services’s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Wison Engineering Services has total assets of CN¥6.2b and current liabilities of CN¥3.9b. Therefore its current liabilities are equivalent to approximately 63% of its total assets. Wison Engineering Services has a fairly high level of current liabilities, boosting its ROCE.

Our Take On Wison Engineering Services’s ROCE

Wison Engineering Services’s ROCE is also pretty low (in absolute terms), making the stock look unattractive on this analysis. 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.