Today we’ll evaluate Nanjing Sample Technology Company Limited (HKG:1708) 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. Then we’ll compare its ROCE 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 ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Nanjing Sample Technology:

0.11 = CN¥286m ÷ (CN¥4.8b – CN¥2.3b) (Based on the trailing twelve months to June 2019.)

Therefore, Nanjing Sample Technology has an ROCE of 11%.

Check out our latest analysis for Nanjing Sample Technology

Is Nanjing Sample Technology’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. It appears that Nanjing Sample Technology’s ROCE is fairly close to the Electronic industry average of 9.9%. Regardless of where Nanjing Sample Technology sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

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In our analysis, Nanjing Sample Technology’s ROCE appears to be 11%, compared to 3 years ago, when its ROCE was 7.6%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Nanjing Sample Technology’s ROCE compares to its industry. Click to see more on past growth.

SEHK:1708 Past Revenue and Net Income, November 17th 2019
SEHK:1708 Past Revenue and Net Income, November 17th 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Nanjing Sample Technology? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Nanjing Sample Technology’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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Nanjing Sample Technology has total assets of CN¥4.8b and current liabilities of CN¥2.3b. As a result, its current liabilities are equal to approximately 47% of its total assets. With this level of current liabilities, Nanjing Sample Technology’s ROCE is boosted somewhat.

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The Bottom Line On Nanjing Sample Technology’s ROCE

Nanjing Sample Technology’s ROCE does look good, but the level of current liabilities also contribute to that. Nanjing Sample Technology 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.

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