Why We Like Zhejiang New Century Hotel Management Co., Ltd.’s (HKG:1158) 8.9% Return On Capital Employed

Today we'll look at Zhejiang New Century Hotel Management Co., Ltd. (HKG:1158) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, 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.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 Zhejiang New Century Hotel Management:

0.089 = CN¥315m ÷ (CN¥4.5b - CN¥933m) (Based on the trailing twelve months to December 2019.)

So, Zhejiang New Century Hotel Management has an ROCE of 8.9%.

View our latest analysis for Zhejiang New Century Hotel Management

Is Zhejiang New Century Hotel Management's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Zhejiang New Century Hotel Management's ROCE is meaningfully higher than the 5.3% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the industry comparison for now, 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. It is possible that there are more rewarding investments out there.

Zhejiang New Century Hotel Management's current ROCE of 8.9% is lower than 3 years ago, when the company reported a 19% ROCE. 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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Zhejiang New Century Hotel Management is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

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 assets of CN¥4.5b and current liabilities of CN¥933m. As a result, its current liabilities are equal to approximately 21% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take 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. 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.