Today we’ll evaluate Zhaojin Mining Industry Company Limited (HKG:1818) to determine whether it could have potential as an investment idea. 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.
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. All else being equal, a better business will have a higher ROCE. 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 Zhaojin Mining Industry:
0.027 = CN¥703m ÷ (CN¥39b – CN¥13b) (Based on the trailing twelve months to June 2019.)
Therefore, Zhaojin Mining Industry has an ROCE of 2.7%.
Is Zhaojin Mining Industry’s ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Zhaojin Mining Industry’s ROCE is meaningfully below the Metals and Mining industry average of 8.3%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Zhaojin Mining Industry’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
Zhaojin Mining Industry’s current ROCE of 2.7% is lower than 3 years ago, when the company reported a 4.1% ROCE. Therefore we wonder if the company is facing new headwinds.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Zhaojin Mining Industry are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Zhaojin Mining Industry.
Zhaojin Mining Industry’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Zhaojin Mining Industry has total assets of CN¥39b and current liabilities of CN¥13b. As a result, its current liabilities are equal to approximately 33% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Zhaojin Mining Industry’s low ROCE is unappealing.
The Bottom Line On Zhaojin Mining Industry’s ROCE
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.