Today we’ll look at China Resources Medical Holdings Company Limited (HKG:1515) and reflect on its potential as an investment. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 China Resources Medical Holdings:
0.08 = CN¥457m ÷ (CN¥7.0b – CN¥1.0b) (Based on the trailing twelve months to June 2018.)
So, China Resources Medical Holdings has an ROCE of 8.0%.
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Is China Resources Medical Holdings’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, China Resources Medical Holdings’s ROCE appears to be significantly below the 12% average in the Healthcare industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, China Resources Medical 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.
As we can see, China Resources Medical Holdings currently has an ROCE of 8.0%, less than the 12% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Resources Medical Holdings.
How China Resources Medical Holdings’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Resources Medical Holdings has total assets of CN¥7.0b and current liabilities of CN¥1.0b. Therefore its current liabilities are equivalent to approximately 15% 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 China Resources Medical Holdings’s ROCE
With that in mind, we’re not overly impressed with China Resources Medical Holdings’s ROCE, so it may not be the most appealing prospect. You might be able to find a better buy than China Resources Medical Holdings. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.