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

Today we'll look at Zhejiang New Century Hotel Management Co., Ltd. (HKG:1158) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 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%.

Check out our latest analysis for Zhejiang New Century Hotel Management

Does Zhejiang New Century Hotel Management Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, Zhejiang New Century Hotel Management's ROCE is meaningfully higher than the 5.0% 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. Readers may find more attractive investment prospects elsewhere.

We can see that, Zhejiang New Century Hotel Management currently has an ROCE of 7.6%, less than the 16% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Zhejiang New Century Hotel Management's ROCE compares to its industry.

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. 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?

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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Zhejiang New Century Hotel Management has total liabilities of CN¥978m and total assets of CN¥4.5b. As a result, its current liabilities are equal to approximately 22% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

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

If Zhejiang New Century Hotel Management continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Zhejiang New Century Hotel Management. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Zhejiang New Century Hotel Management 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 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. Thank you for reading.