Is Ahsay Backup Software Development Company Limited (HKG:8290) Investing Effectively In Its Business?

Today we'll look at Ahsay Backup Software Development Company Limited (HKG:8290) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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. Ultimately, it is a useful but imperfect metric. 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 Ahsay Backup Software Development:

0.06 = HK$5.0m ÷ (HK$106m - HK$24m) (Based on the trailing twelve months to June 2019.)

Therefore, Ahsay Backup Software Development has an ROCE of 6.0%.

Check out our latest analysis for Ahsay Backup Software Development

Does Ahsay Backup Software Development Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Ahsay Backup Software Development's ROCE is around the 6.0% average reported by the Software industry. Aside from the industry comparison, Ahsay Backup Software Development's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Ahsay Backup Software Development reported an ROCE of 6.0% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can see in the image below how Ahsay Backup Software Development's ROCE compares to its industry. Click to see more on past growth.

It is important to remember that ROCE shows past performance, and is 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. ROCE is only a point-in-time measure. You can check if Ahsay Backup Software Development has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Ahsay Backup Software Development's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Ahsay Backup Software Development has total liabilities of HK$24m and total assets of HK$106m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On Ahsay Backup Software Development's ROCE

That said, Ahsay Backup Software Development's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Ahsay Backup Software Development. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.