Today we are going to look at China Chengtong Development Group Limited (HKG:217) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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. 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. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
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 China Chengtong Development Group:
0.00039 = HK$1.2m ÷ (HK$3.6b – HK$528m) (Based on the trailing twelve months to June 2019.)
Therefore, China Chengtong Development Group has an ROCE of 0.04%.
Does China Chengtong Development Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, China Chengtong Development Group’s ROCE appears meaningfully below the 7.6% average reported by the Trade Distributors industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how China Chengtong Development Group stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
China Chengtong Development Group’s current ROCE of 0.04% is lower than 3 years ago, when the company reported a 0.9% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how China Chengtong Development 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. 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 China Chengtong Development Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect China Chengtong Development Group’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
China Chengtong Development Group has current liabilities of HK$528m and total assets of HK$3.6b. As a result, its current liabilities are equal to approximately 15% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From China Chengtong Development Group’s ROCE
That’s not a bad thing, however China Chengtong Development Group has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than China Chengtong Development Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.
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.