Should You Like HiTech Group Australia Limited’s (ASX:HIT) High Return On Capital Employed?

Today we'll look at HiTech Group Australia Limited (ASX:HIT) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 HiTech Group Australia:

0.54 = AU$3.8m ÷ (AU$9.0m - AU$1.8m) (Based on the trailing twelve months to December 2018.)

So, HiTech Group Australia has an ROCE of 54%.

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Is HiTech Group Australia's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, HiTech Group Australia's ROCE is meaningfully higher than the 19% average in the Professional Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, HiTech Group Australia's ROCE in absolute terms currently looks quite high.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. You can check if HiTech Group Australia has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect HiTech Group Australia's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.

HiTech Group Australia has total liabilities of AU$1.8m and total assets of AU$9.0m. As a result, its current liabilities are equal to approximately 20% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

The Bottom Line On HiTech Group Australia's ROCE

This is good to see, and with such a high ROCE, HiTech Group Australia may be worth a closer look. HiTech Group Australia 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.