Today we’ll look at Shougang Fushan Resources Group Limited (HKG:639) 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. 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. 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.
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 Shougang Fushan Resources Group:
0.083 = HK$1.6b ÷ (HK$21b – HK$2.8b) (Based on the trailing twelve months to December 2019.)
Therefore, Shougang Fushan Resources Group has an ROCE of 8.3%.
Does Shougang Fushan Resources Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Shougang Fushan Resources Group’s ROCE appears to be substantially greater than the 6.2% average in the Metals and Mining industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the industry comparison for now, Shougang Fushan Resources Group’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.
In our analysis, Shougang Fushan Resources Group’s ROCE appears to be 8.3%, compared to 3 years ago, when its ROCE was 0.9%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Shougang Fushan Resources Group’s ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Shougang Fushan Resources Group are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Shougang Fushan Resources Group’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Shougang Fushan Resources Group has current liabilities of HK$2.8b and total assets of HK$21b. As a result, its current liabilities are equal to approximately 13% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On Shougang Fushan Resources Group’s ROCE
That said, Shougang Fushan Resources Group’s ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Shougang Fushan Resources Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org. 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.
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