Today we’ll evaluate PAX Global Technology Limited (HKG:327) to determine whether it could have potential as an investment idea. 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. 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 PAX Global Technology:
0.16 = HK$745m ÷ (HK$6.5b – HK$2.0b) (Based on the trailing twelve months to June 2019.)
Therefore, PAX Global Technology has an ROCE of 16%.
Does PAX Global Technology Have A Good ROCE?
One way to assess ROCE is to compare similar companies. PAX Global Technology’s ROCE appears to be substantially greater than the 10% average in the Electronic industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how PAX Global Technology compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how PAX Global Technology’s ROCE compares to its industry.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for PAX Global Technology.
How PAX Global Technology’s Current Liabilities Impact Its 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.
PAX Global Technology has total assets of HK$6.5b and current liabilities of HK$2.0b. As a result, its current liabilities are equal to approximately 31% of its total assets. With this level of current liabilities, PAX Global Technology’s ROCE is boosted somewhat.
Our Take On PAX Global Technology’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. PAX Global Technology looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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If you spot an error that warrants correction, please contact the editor at email@example.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.