Is New Times Energy Corporation Limited's (HKG:166) Capital Allocation Ability Worth Your Time?

Today we'll look at New Times Energy Corporation Limited (HKG:166) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?

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 New Times Energy:

0.09 = HK$162m ÷ (HK$3.6b - HK$75m) (Based on the trailing twelve months to June 2018.)

So, New Times Energy has an ROCE of 9.0%.

View our latest analysis for New Times Energy

Is New Times Energy's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, New Times Energy's ROCE appears to be around the 9.9% average of the Oil and Gas industry. Setting aside the industry comparison for now, New Times Energy's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

New Times Energy delivered an ROCE of 9.0%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.

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. ROCE is only a point-in-time measure. Remember that most companies like New Times Energy are cyclical businesses. You can check if New Times Energy has cyclical profits by looking at this freegraph of past earnings, revenue and cash flow.

Do New Times Energy's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

New Times Energy has total liabilities of HK$75m and total assets of HK$3.6b. Therefore its current liabilities are equivalent to approximately 2.1% of its total assets. With low levels of current liabilities, at least New Times Energy's mediocre ROCE is not unduly boosted.

The Bottom Line On New Times Energy's ROCE

Based on this information, New Times Energy appears to be a mediocre business. You might be able to find a better buy than New Times Energy. If you want a selection of possible winners, check out this freelist of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you are like me, then you will not want to miss this freelist of growing companies that insiders are 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 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.