Today we are going to look at China Everbright Water Limited (SGX:U9E) 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.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Everbright Water:
0.078 = HK$1.4b ÷ (HK$23b – HK$4.6b) (Based on the trailing twelve months to December 2019.)
Therefore, China Everbright Water has an ROCE of 7.8%.
Is China Everbright Water’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that China Everbright Water’s ROCE is fairly close to the Water Utilities industry average of 7.3%. Aside from the industry comparison, China Everbright Water’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
We can see that, China Everbright Water currently has an ROCE of 7.8% compared to its ROCE 3 years ago, which was 5.2%. This makes us wonder if the company is improving. The image below shows how China Everbright Water’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Everbright Water.
What Are Current Liabilities, And How Do They Affect China Everbright Water’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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Everbright Water has total assets of HK$23b and current liabilities of HK$4.6b. Therefore its current liabilities are equivalent to approximately 20% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On China Everbright Water’s ROCE
With that in mind, we’re not overly impressed with China Everbright Water’s ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than China Everbright Water. 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).
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email 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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.