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Today we'll evaluate Nexion Technologies Limited (HKG:8420) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. 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. Generally speaking a higher ROCE is better. 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?
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 Nexion Technologies:
0.13 = US$2.1m ÷ (US$18m - US$1.9m) (Based on the trailing twelve months to March 2019.)
Therefore, Nexion Technologies has an ROCE of 13%.
View our latest analysis for Nexion Technologies
Is Nexion Technologies's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Nexion Technologies's ROCE is fairly close to the IT industry average of 12%. Independently of how Nexion Technologies compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Nexion Technologies's current ROCE of 13% is lower than 3 years ago, when the company reported a 52% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Nexion Technologies's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Nexion Technologies has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.