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Today we’ll evaluate Datang Environment Industry Group Co., Ltd. (HKG:1272) 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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. Generally speaking a higher ROCE is better. 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 Datang Environment Industry Group:
0.12 = CN¥1.3b ÷ (CN¥18b – CN¥8.4b) (Based on the trailing twelve months to June 2018.)
So, Datang Environment Industry Group has an ROCE of 12%.
Is Datang Environment Industry Group’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Datang Environment Industry Group’s ROCE is fairly close to the Commercial Services industry average of 11%. Independently of how Datang Environment Industry Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Datang Environment Industry Group’s current ROCE of 12% is lower than its ROCE in the past, which was 17%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. You can check if Datang Environment Industry Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Datang Environment Industry 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.
Datang Environment Industry Group has total liabilities of CN¥8.4b and total assets of CN¥18b. As a result, its current liabilities are equal to approximately 46% of its total assets. With this level of current liabilities, Datang Environment Industry Group’s ROCE is boosted somewhat.
Our Take On Datang Environment Industry Group’s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Of course you might be able to find a better stock than Datang Environment Industry Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.