Today we’ll evaluate Zhengzhou Coal Mining Machinery Group Company Limited (HKG:564) to determine whether it could have potential as an investment idea. 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding 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. 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 Zhengzhou Coal Mining Machinery Group:
0.069 = CN¥1.1b ÷ (CN¥27b – CN¥11b) (Based on the trailing twelve months to September 2018.)
Therefore, Zhengzhou Coal Mining Machinery Group has an ROCE of 6.9%.
Is Zhengzhou Coal Mining Machinery Group’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Zhengzhou Coal Mining Machinery Group’s ROCE appears to be significantly below the 11% average in the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Zhengzhou Coal Mining Machinery Group’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Zhengzhou Coal Mining Machinery Group delivered an ROCE of 6.9%, 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. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Zhengzhou Coal Mining Machinery Group.
Zhengzhou Coal Mining Machinery 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. 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.
Zhengzhou Coal Mining Machinery Group has total liabilities of CN¥11b and total assets of CN¥27b. As a result, its current liabilities are equal to approximately 40% of its total assets. Zhengzhou Coal Mining Machinery Group’s middling level of current liabilities have the effect of boosting its ROCE a bit.
What We Can Learn From Zhengzhou Coal Mining Machinery Group’s ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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 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. Thank you for reading.