China Parenting Network Holdings Limited’s (HKG:1736) Investment Returns Are Lagging Its Industry

Today we’ll evaluate China Parenting Network Holdings Limited (HKG:1736) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First up, we’ll look at what ROCE is and how we calculate it. 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 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. Ultimately, it is a useful but imperfect metric. 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?

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 Parenting Network Holdings:

0.085 = CN¥36m ÷ (CN¥419m – CN¥21m) (Based on the trailing twelve months to June 2018.)

So, China Parenting Network Holdings has an ROCE of 8.5%.

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Does China Parenting Network Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see China Parenting Network Holdings’s ROCE is meaningfully below the Interactive Media and Services industry average of 14%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, China Parenting Network Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

China Parenting Network Holdings’s current ROCE of 8.5% is lower than its ROCE in the past, which was 70%, 3 years ago. This makes us wonder if the business is facing new challenges.

SEHK:1736 Last Perf January 20th 19
SEHK:1736 Last Perf January 20th 19

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. How cyclical is China Parenting Network Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect China Parenting Network Holdings’s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.

China Parenting Network Holdings has total assets of CN¥419m and current liabilities of CN¥21m. Therefore its current liabilities are equivalent to approximately 5.0% of its total assets. With low levels of current liabilities, at least China Parenting Network Holdings’s mediocre ROCE is not unduly boosted.

Our Take On China Parenting Network Holdings’s ROCE

If performance improves, then China Parenting Network Holdings may be an OK investment, especially at the right valuation. Of course you might be able to find a better stock than China Parenting Network Holdings. 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.

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.