Why Energy International Investments Holdings Limited’s (HKG:353) Return On Capital Employed Might Be A Concern
Today we'll look at Energy International Investments Holdings Limited (HKG:353) 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.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Energy International Investments Holdings:
0.053 = HK$76m ÷ (HK$2.0b - HK$584m) (Based on the trailing twelve months to December 2019.)
So, Energy International Investments Holdings has an ROCE of 5.3%.
See our latest analysis for Energy International Investments Holdings
Does Energy International Investments Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Energy International Investments Holdings's ROCE appears to be significantly below the 7.8% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Energy International Investments Holdings'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.
Energy International Investments Holdings delivered an ROCE of 5.3%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how Energy International Investments Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 only a point-in-time measure. We note Energy International Investments Holdings could be considered a cyclical business. You can check if Energy International Investments Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Energy International Investments Holdings's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Energy International Investments Holdings has total assets of HK$2.0b and current liabilities of HK$584m. As a result, its current liabilities are equal to approximately 29% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Energy International Investments Holdings's ROCE
If Energy International Investments Holdings 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 Energy International Investments Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
