Should You Worry About Changmao Biochemical Engineering Company Limited’s (HKG:954) ROCE?

Today we are going to look at Changmao Biochemical Engineering Company Limited (HKG:954) to see whether it might be an attractive investment prospect. 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. Last but not least, we'll look at what impact its current liabilities have on 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. 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 Changmao Biochemical Engineering:

0.032 = CN¥7.1m ÷ (CN¥703m - CN¥105m) (Based on the trailing twelve months to June 2018.)

So, Changmao Biochemical Engineering has an ROCE of 3.2%.

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Is Changmao Biochemical Engineering's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Changmao Biochemical Engineering's ROCE is meaningfully below the Chemicals industry average of 11%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Changmao Biochemical Engineering stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

Changmao Biochemical Engineering's current ROCE of 3.2% is lower than 3 years ago, when the company reported a 7.1% ROCE. Therefore we wonder if the company is facing new headwinds.

When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is only a point-in-time measure. You can check if Changmao Biochemical Engineering has cyclical profits by looking at this freegraph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Changmao Biochemical Engineering's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.

Changmao Biochemical Engineering has total liabilities of CN¥105m and total assets of CN¥703m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

Our Take On Changmao Biochemical Engineering's ROCE

That's not a bad thing, however Changmao Biochemical Engineering has a weak ROCE and may not be an attractive investment. But note: Changmao Biochemical Engineering may not be the best stock to buy. So take a peek at this freelist of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Changmao Biochemical Engineering better if I see some big insider buys. While we wait, check out this freelist 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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.