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Today we’ll evaluate Wuxi Sunlit Science and Technology Company Limited (HKG:1289) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. 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?
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 Wuxi Sunlit Science and Technology:
0.058 = CN¥36m ÷ (CN¥717m – CN¥87m) (Based on the trailing twelve months to December 2018.)
Therefore, Wuxi Sunlit Science and Technology has an ROCE of 5.8%.
Is Wuxi Sunlit Science and Technology’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Wuxi Sunlit Science and Technology’s ROCE appears meaningfully below the 10% average reported by the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Wuxi Sunlit Science and Technology stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Wuxi Sunlit Science and Technology reported an ROCE of 5.8% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Wuxi Sunlit Science and Technology has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Wuxi Sunlit Science and Technology’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Wuxi Sunlit Science and Technology has total liabilities of CN¥87m and total assets of CN¥717m. Therefore its current liabilities are equivalent to approximately 12% 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 Wuxi Sunlit Science and Technology’s ROCE
That said, Wuxi Sunlit Science and Technology’s ROCE is mediocre, there may be more attractive investments around. 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).
I will like Wuxi Sunlit Science and Technology better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.