Today we’ll look at Geely Automobile Holdings Limited (HKG:175) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Geely Automobile Holdings:
0.20 = CN¥10b ÷ (CN¥92b – CN¥42b) (Based on the trailing twelve months to June 2019.)
So, Geely Automobile Holdings has an ROCE of 20%.
Does Geely Automobile Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Geely Automobile Holdings’s ROCE is meaningfully higher than the 6.4% average in the Auto industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Geely Automobile Holdings’s ROCE is currently very good.
Our data shows that Geely Automobile Holdings currently has an ROCE of 20%, compared to its ROCE of 9.6% 3 years ago. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Geely Automobile Holdings’s past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Geely Automobile Holdings.
Geely Automobile Holdings’s Current Liabilities And Their Impact On Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Geely Automobile Holdings has total liabilities of CN¥42b and total assets of CN¥92b. As a result, its current liabilities are equal to approximately 46% of its total assets. Geely Automobile Holdings’s ROCE is boosted somewhat by its middling amount of current liabilities.
What We Can Learn From Geely Automobile Holdings’s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. Geely Automobile Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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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