Is Changmao Biochemical Engineering Company Limited's (HKG:954) Capital Allocation Ability Worth Your Time?

Today we'll evaluate Changmao Biochemical Engineering Company Limited (HKG:954) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding 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. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

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 Changmao Biochemical Engineering:

0.13 = CN¥86m ÷ (CN¥737m - CN¥88m) (Based on the trailing twelve months to June 2019.)

Therefore, Changmao Biochemical Engineering has an ROCE of 13%.

View our latest analysis for Changmao Biochemical Engineering

Is Changmao Biochemical Engineering's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Changmao Biochemical Engineering's ROCE appears to be around the 12% average of the Chemicals industry. Independently of how Changmao Biochemical Engineering compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

In our analysis, Changmao Biochemical Engineering's ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 9.0%. This makes us think about whether the company has been reinvesting shrewdly.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. If Changmao Biochemical Engineering is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Changmao Biochemical Engineering'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Changmao Biochemical Engineering has total liabilities of CN¥88m and total assets of CN¥737m. As a result, its current liabilities are equal to approximately 12% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From Changmao Biochemical Engineering's ROCE

Overall, Changmao Biochemical Engineering has a decent ROCE and could be worthy of further research. Changmao Biochemical Engineering looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like Changmao Biochemical Engineering 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 editorial-team@simplywallst.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.