Why China Oriental Group Company Limited’s (HKG:581) Return On Capital Employed Is Impressive

Today we’ll look at China Oriental Group Company Limited (HKG:581) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?

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 Oriental Group:

0.23 = CN¥4.5b ÷ (CN¥32b – CN¥13b) (Based on the trailing twelve months to June 2019.)

Therefore, China Oriental Group has an ROCE of 23%.

View our latest analysis for China Oriental Group

Does China Oriental Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that China Oriental Group’s ROCE is meaningfully better than the 8.1% average in the Metals and Mining 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. Putting aside its position relative to its industry for now, in absolute terms, China Oriental Group’s ROCE is currently very good.

We can see that, China Oriental Group currently has an ROCE of 23% compared to its ROCE 3 years ago, which was 5.3%. This makes us wonder if the company is improving. Take a look at the image below to see how China Oriental Group’s past growth compares to the average in its industry.

SEHK:581 Past Revenue and Net Income, September 23rd 2019
SEHK:581 Past Revenue and Net Income, September 23rd 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, China Oriental Group could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Oriental Group.

What Are Current Liabilities, And How Do They Affect China Oriental Group’s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

China Oriental Group has total liabilities of CN¥13b and total assets of CN¥32b. As a result, its current liabilities are equal to approximately 39% of its total assets. A medium level of current liabilities boosts China Oriental Group’s ROCE somewhat.

The Bottom Line On China Oriental Group’s ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than China Oriental Group 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.

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

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 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. Thank you for reading.