Today we’ll look at China Ludao Technology Company Limited (HKG:2023) 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. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Ultimately, it is a useful but imperfect metric. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for China Ludao Technology:
0.059 = CN¥31m ÷ (CN¥793m – CN¥211m) (Based on the trailing twelve months to June 2018.)
So, China Ludao Technology has an ROCE of 5.9%.
Is China Ludao Technology’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, China Ludao Technology’s ROCE appears to be significantly below the 11% average in the Household Products industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, China Ludao Technology’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.
China Ludao Technology’s current ROCE of 5.9% is lower than 3 years ago, when the company reported a 9.4% ROCE. Therefore we wonder if the company is facing new headwinds.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is China Ludao Technology? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
China Ludao Technology’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 Ludao Technology has total assets of CN¥793m and current liabilities of CN¥211m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On China Ludao Technology’s ROCE
With that in mind, we’re not overly impressed with China Ludao Technology’s ROCE, so it may not be the most appealing prospect. You might be able to find a better buy than China Ludao Technology. 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 China Ludao Technology better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.