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Today we’ll evaluate China Chengtong Development Group Limited (HKG:217) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Chengtong Development Group:
0.00084 = HK$2.5m ÷ (HK$3.6b – HK$641m) (Based on the trailing twelve months to December 2018.)
So, China Chengtong Development Group has an ROCE of 0.08%.
Is China Chengtong Development Group’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, China Chengtong Development Group’s ROCE appears meaningfully below the 5.8% average reported by the Trade Distributors industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how China Chengtong Development Group stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
As we can see, China Chengtong Development Group currently has an ROCE of 0.08% compared to its ROCE 3 years ago, which was 0.06%. 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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If China Chengtong Development Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
China Chengtong Development Group’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
China Chengtong Development Group has total liabilities of HK$641m and total assets of HK$3.6b. As a result, its current liabilities are equal to approximately 18% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From China Chengtong Development Group’s ROCE
China Chengtong Development Group has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like China Chengtong Development Group 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.