In This Article:
Today we’ll look at Chinasoft International Limited (HKG:354) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. 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.’
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 Chinasoft International:
0.12 = CN¥767m ÷ (CN¥8.9b – CN¥2.4b) (Based on the trailing twelve months to June 2018.)
So, Chinasoft International has an ROCE of 12%.
See our latest analysis for Chinasoft International
Is Chinasoft International’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Chinasoft International’s ROCE appears to be around the 12% average of the IT industry. Regardless of where Chinasoft International sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, Chinasoft International’s ROCE appears to be 12%, compared to 3 years ago, when its ROCE was 9.2%. This makes us think the business might be improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Chinasoft International.
How Chinasoft International’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 counteract this, we check if a company has high current liabilities, relative to its total assets.