Today we’ll look at Shanghai Electric Group Company Limited (HKG:2727) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?
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 Shanghai Electric Group:
0.052 = CN¥5.7b ÷ (CN¥255b – CN¥146b) (Based on the trailing twelve months to June 2019.)
Therefore, Shanghai Electric Group has an ROCE of 5.2%.
Does Shanghai Electric Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Shanghai Electric Group’s ROCE appears to be significantly below the 8.1% average in the Electrical industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Shanghai Electric Group’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.
You can see in the image below how Shanghai Electric Group’s ROCE compares to its industry.
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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Shanghai Electric Group’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Shanghai Electric Group has total assets of CN¥255b and current liabilities of CN¥146b. As a result, its current liabilities are equal to approximately 57% of its total assets. Shanghai Electric Group has a fairly high level of current liabilities, meaningfully impacting its ROCE.
The Bottom Line On Shanghai Electric Group’s ROCE
Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. Of course, you might also be able to find a better stock than Shanghai Electric Group. 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).
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.
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. Thank you for reading.