Why You Should Care About Computime Group Limited’s (HKG:320) Low Return On Capital

Today we are going to look at Computime Group Limited (HKG:320) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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.

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 Computime Group:

0.0044 = HK$5.6m ÷ (HK$2.2b - HK$957m) (Based on the trailing twelve months to September 2019.)

Therefore, Computime Group has an ROCE of 0.4%.

Check out our latest analysis for Computime Group

Is Computime Group's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Computime Group's ROCE appears meaningfully below the 8.9% average reported by the Electronic industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Computime Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. It is likely that there are more attractive prospects out there.

We can see that, Computime Group currently has an ROCE of 0.4%, less than the 12% it reported 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Computime Group's past growth compares to other companies.

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. ROCE is, after all, simply a snap shot of a single year. If Computime Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Computime Group's 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Computime Group has total assets of HK$2.2b and current liabilities of HK$957m. As a result, its current liabilities are equal to approximately 43% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Computime Group's ROCE is concerning.

What We Can Learn From Computime Group's ROCE

So researching other companies may be a better use of your time. Of course, you might also be able to find a better stock than Computime Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Computime Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.