What Can We Make Of Yadea Group Holdings Ltd.’s (HKG:1585) High Return On Capital?

Today we are going to look at Yadea Group Holdings Ltd. (HKG:1585) 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.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Ultimately, it is a useful but imperfect metric. 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?

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 Yadea Group Holdings:

0.13 = CN¥418m ÷ (CN¥11b - CN¥7.6b) (Based on the trailing twelve months to December 2019.)

So, Yadea Group Holdings has an ROCE of 13%.

Check out our latest analysis for Yadea Group Holdings

Is Yadea Group Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Yadea Group Holdings's ROCE is meaningfully better than the 4.4% average in the Auto 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. Separate from Yadea Group Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Yadea Group Holdings's current ROCE of 13% is lower than its ROCE in the past, which was 21%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Yadea Group Holdings'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. You can check if Yadea Group Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Yadea Group Holdings's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Yadea Group Holdings has current liabilities of CN¥7.6b and total assets of CN¥11b. Therefore its current liabilities are equivalent to approximately 70% of its total assets. Yadea Group Holdings's current liabilities are fairly high, which increases its ROCE significantly.

The Bottom Line On Yadea Group Holdings's ROCE

While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. Yadea Group Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.