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Here’s why Shaanxi Northwest New Technology Industry Company Limited’s (HKG:8258) Returns On Capital Matters So Much

Today we are going to look at Shaanxi Northwest New Technology Industry Company Limited (HKG:8258) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, 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.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Shaanxi Northwest New Technology Industry:

0.08 = CN¥13m ÷ (CN¥171m - CN¥11m) (Based on the trailing twelve months to September 2019.)

So, Shaanxi Northwest New Technology Industry has an ROCE of 8.0%.

Check out our latest analysis for Shaanxi Northwest New Technology Industry

Does Shaanxi Northwest New Technology Industry Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Shaanxi Northwest New Technology Industry's ROCE appears meaningfully below the 11% average reported by the Chemicals industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Shaanxi Northwest New Technology Industry 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.

In our analysis, Shaanxi Northwest New Technology Industry's ROCE appears to be 8.0%, compared to 3 years ago, when its ROCE was 2.5%. This makes us think the business might be improving. You can see in the image below how Shaanxi Northwest New Technology Industry's ROCE compares to its industry. Click to see more on past growth.

SEHK:8258 Past Revenue and Net Income April 3rd 2020
SEHK:8258 Past Revenue and Net Income April 3rd 2020

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. You can check if Shaanxi Northwest New Technology Industry has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Shaanxi Northwest New Technology Industry's Current Liabilities Skew Its 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 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.

Shaanxi Northwest New Technology Industry has total assets of CN¥171m and current liabilities of CN¥11m. As a result, its current liabilities are equal to approximately 6.6% of its total assets. With low levels of current liabilities, at least Shaanxi Northwest New Technology Industry's mediocre ROCE is not unduly boosted.

What We Can Learn From Shaanxi Northwest New Technology Industry's ROCE

Shaanxi Northwest New Technology Industry looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.

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. Thank you for reading.