Today we are going to look at China Oriental Group Company Limited (HKG:581) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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 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. 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.’
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 Oriental Group:
0.45 = CN¥6.3b ÷ (CN¥26b – CN¥9.4b) (Based on the trailing twelve months to June 2018.)
Therefore, China Oriental Group has an ROCE of 45%.
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Is China Oriental Group’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, China Oriental Group’s ROCE is meaningfully higher than the 10% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, China Oriental Group’s ROCE is currently very good.
In our analysis, China Oriental Group’s ROCE appears to be 45%, compared to 3 years ago, when its ROCE was 4.2%. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. We note China Oriental Group could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect China Oriental Group’s 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
China Oriental Group has total liabilities of CN¥9.4b and total assets of CN¥26b. Therefore its current liabilities are equivalent to approximately 36% of its total assets. A medium level of current liabilities boosts China Oriental Group’s ROCE somewhat.
The Bottom Line On China Oriental Group’s ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. But note: China Oriental Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like China Oriental Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.