Are Zhejiang New Century Hotel Management Co., Ltd.’s (HKG:1158) High Returns Really That Great?

Today we are going to look at Zhejiang New Century Hotel Management Co., Ltd. (HKG:1158) to see whether it might be an attractive investment prospect. 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, 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.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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 Zhejiang New Century Hotel Management:

0.076 = CN¥265m ÷ (CN¥4.5b - CN¥978m) (Based on the trailing twelve months to June 2019.)

So, Zhejiang New Century Hotel Management has an ROCE of 7.6%.

See our latest analysis for Zhejiang New Century Hotel Management

Does Zhejiang New Century Hotel Management Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Zhejiang New Century Hotel Management's ROCE is meaningfully better than the 5.4% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Aside from the industry comparison, Zhejiang New Century Hotel Management'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.

Zhejiang New Century Hotel Management's current ROCE of 7.6% is lower than its ROCE in the past, which was 16%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Zhejiang New Century Hotel Management's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Zhejiang New Century Hotel Management.

Do Zhejiang New Century Hotel Management's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.

Zhejiang New Century Hotel Management has total assets of CN¥4.5b and current liabilities of CN¥978m. As a result, its current liabilities are equal to approximately 22% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Zhejiang New Century Hotel Management's ROCE

With that in mind, we're not overly impressed with Zhejiang New Century Hotel Management's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Zhejiang New Century Hotel Management. 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.

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.

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. Thank you for reading.