Today we are going to look at Nexion Technologies Limited (HKG:8420) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the 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.
How Do You Calculate Return On Capital Employed?
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:
0.082 = US$1.2m ÷ (US$17m – US$1.5m) (Based on the trailing twelve months to June 2019.)
So, Nexion Technologies has an ROCE of 8.2%.
Does Nexion Technologies Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Nexion Technologies’s ROCE is meaningfully below the IT industry average of 11%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Nexion Technologies’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Nexion Technologies’s current ROCE of 8.2% is lower than its ROCE in the past, which was 39%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Nexion Technologies’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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Nexion Technologies? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Nexion Technologies’s Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Nexion Technologies has total liabilities of US$1.5m and total assets of US$17m. Therefore its current liabilities are equivalent to approximately 8.8% of its total assets. With low levels of current liabilities, at least Nexion Technologies’s mediocre ROCE is not unduly boosted.
The Bottom Line On Nexion Technologies’s ROCE
If performance improves, then Nexion Technologies may be an OK investment, especially at the right valuation. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.
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 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.