How Do Transtech Optelecom Science Holdings Limited’s (HKG:8465) Returns Compare To Its Industry?

Today we'll look at Transtech Optelecom Science Holdings Limited (HKG:8465) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

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

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

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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.

So, How Do We Calculate ROCE?

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 Transtech Optelecom Science Holdings:

0.06 = HK$41m ÷ (HK$750m - HK$66m) (Based on the trailing twelve months to September 2019.)

So, Transtech Optelecom Science Holdings has an ROCE of 6.0%.

Check out our latest analysis for Transtech Optelecom Science Holdings

Is Transtech Optelecom Science Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Transtech Optelecom Science Holdings's ROCE appears meaningfully below the 9.0% average reported by the Communications industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Transtech Optelecom Science Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Transtech Optelecom Science Holdings's current ROCE of 6.0% is lower than 3 years ago, when the company reported a 21% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Transtech Optelecom Science Holdings's past growth compares to other companies.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Transtech Optelecom Science Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Transtech Optelecom Science Holdings's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Transtech Optelecom Science Holdings has total liabilities of HK$66m and total assets of HK$750m. As a result, its current liabilities are equal to approximately 8.8% of its total assets. Transtech Optelecom Science Holdings has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

Our Take On Transtech Optelecom Science Holdings's ROCE

If performance improves, then Transtech Optelecom Science Holdings may be an OK investment, especially at the right valuation. Of course, you might also be able to find a better stock than Transtech Optelecom Science Holdings. 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).

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.