Today we are going to look at Sinopec Shanghai Petrochemical Company Limited (HKG:338) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Sinopec Shanghai Petrochemical:
0.23 = CN¥7.1b ÷ (CN¥42b – CN¥12b) (Based on the trailing twelve months to September 2018.)
Therefore, Sinopec Shanghai Petrochemical has an ROCE of 23%.
Is Sinopec Shanghai Petrochemical’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Sinopec Shanghai Petrochemical’s ROCE appears to be substantially greater than the 11% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Sinopec Shanghai Petrochemical’s ROCE in absolute terms currently looks quite high.
In our analysis, Sinopec Shanghai Petrochemical’s ROCE appears to be 23%, compared to 3 years ago, when its ROCE was 10.0%. This makes us wonder if the company is improving.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Sinopec Shanghai Petrochemical.
Do Sinopec Shanghai Petrochemical’s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Sinopec Shanghai Petrochemical has total assets of CN¥42b and current liabilities of CN¥12b. As a result, its current liabilities are equal to approximately 29% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
Our Take On Sinopec Shanghai Petrochemical’s ROCE
With low current liabilities and a high ROCE, Sinopec Shanghai Petrochemical could be worthy of further investigation. Of course you might be able to find a better stock than Sinopec Shanghai Petrochemical. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.