Why We Like China Oriental Group Company Limited’s (HKG:581) 22% Return On Capital Employed

Today we are going to look at China Oriental Group Company Limited (HKG:581) to see whether it might be an attractive investment prospect. 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. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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.

How Do You Calculate Return On Capital Employed?

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 China Oriental Group:

0.22 = CN¥4.4b ÷ (CN¥32b – CN¥13b) (Based on the trailing twelve months to June 2019.)

So, China Oriental Group has an ROCE of 22%.

Check out our latest analysis for China Oriental Group

Is China Oriental Group’s ROCE Good?

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 7.8% 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. Regardless of the industry comparison, in absolute terms, China Oriental Group’s ROCE currently appears to be excellent.

We can see that, China Oriental Group currently has an ROCE of 22% compared to its ROCE 3 years ago, which was 5.3%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how China Oriental Group’s past growth compares to other companies.

SEHK:581 Past Revenue and Net Income, January 9th 2020
SEHK:581 Past Revenue and Net Income, January 9th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like China Oriental Group are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Oriental Group.

China Oriental Group’s Current Liabilities And Their Impact On 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. 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 assets of CN¥32b and current liabilities of CN¥13b. Therefore its current liabilities are equivalent to approximately 39% of its total assets. China Oriental Group has a medium level of current liabilities, boosting its ROCE somewhat.

The Bottom Line On China Oriental Group’s ROCE

Even so, it has a great ROCE, and could be an attractive 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.