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Today we’ll evaluate China Ludao Technology Company Limited (HKG:2023) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. 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.’
So, How Do We Calculate ROCE?
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:
0.066 = CN¥36m ÷ (CN¥796m – CN¥258m) (Based on the trailing twelve months to December 2018.)
So, China Ludao Technology has an ROCE of 6.6%.
Is China Ludao Technology’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, China Ludao Technology’s ROCE appears to be significantly below the 8.4% average in the Household Products industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how China Ludao Technology stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
In our analysis, China Ludao Technology’s ROCE appears to be 6.6%, compared to 3 years ago, when its ROCE was 1.1%. This makes us think about whether the company has been reinvesting shrewdly.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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.
Do China Ludao Technology’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
China Ludao Technology has total assets of CN¥796m and current liabilities of CN¥258m. As a result, its current liabilities are equal to approximately 32% of its total assets. China Ludao Technology has a medium level of current liabilities, which would boost its ROCE somewhat.
Our Take On China Ludao Technology’s ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better investment 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.
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 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.