Today we’ll evaluate Haitian International Holdings Limited (HKG:1882) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
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.
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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Haitian International Holdings:
0.14 = CN¥1.8b ÷ (CN¥18b – CN¥5.5b) (Based on the trailing twelve months to June 2019.)
So, Haitian International Holdings has an ROCE of 14%.
Does Haitian International Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Haitian International Holdings’s ROCE is meaningfully higher than the 11% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Haitian International Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Haitian International Holdings’s ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Haitian International Holdings’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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Haitian International Holdings has current liabilities of CN¥5.5b and total assets of CN¥18b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Haitian International Holdings’s ROCE
This is good to see, and with a sound ROCE, Haitian International Holdings could be worth a closer look. There might be better investments than Haitian International Holdings 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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