Today we are going to look at West China Cement Limited (HKG:2233) 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. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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’.
How Do You Calculate Return On Capital Employed?
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 West China Cement:
0.18 = CN¥1.7b ÷ (CN¥14b – CN¥4.3b) (Based on the trailing twelve months to June 2019.)
Therefore, West China Cement has an ROCE of 19%.
Is West China Cement’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that West China Cement’s ROCE is fairly close to the Basic Materials industry average of 18%. Regardless of where West China Cement sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Our data shows that West China Cement currently has an ROCE of 19%, compared to its ROCE of 1.0% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 West China Cement.
Do West China Cement’s Current Liabilities Skew 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 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.
West China Cement has total liabilities of CN¥4.3b and total assets of CN¥14b. Therefore its current liabilities are equivalent to approximately 32% of its total assets. West China Cement has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On West China Cement’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. There might be better investments than West China Cement out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like West China Cement better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 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. Thank you for reading.