Are Xinyi Solar Holdings Limited’s (HKG:968) High Returns Really That Great?

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Today we are going to look at Xinyi Solar Holdings Limited (HKG:968) 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. Second, we’ll look at its ROCE compared to similar companies. 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. In general, businesses with a higher ROCE are usually better quality. 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.’

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 Xinyi Solar Holdings:

0.14 = HK$2.5b ÷ (HK$24b – HK$6.7b) (Based on the trailing twelve months to December 2018.)

So, Xinyi Solar Holdings has an ROCE of 14%.

Check out our latest analysis for Xinyi Solar Holdings

Is Xinyi Solar Holdings’s ROCE Good?

One way to assess ROCE is to compare similar companies. Xinyi Solar Holdings’s ROCE appears to be substantially greater than the 6.1% average in the Semiconductor industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Xinyi Solar Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

SEHK:968 Past Revenue and Net Income, April 30th 2019
SEHK:968 Past Revenue and Net Income, April 30th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Xinyi Solar Holdings’s Current Liabilities And Their Impact On Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Xinyi Solar Holdings has total assets of HK$24b and current liabilities of HK$6.7b. As a result, its current liabilities are equal to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From Xinyi Solar Holdings’s ROCE

This is good to see, and with a sound ROCE, Xinyi Solar Holdings could be worth a closer look. There might be better investments than Xinyi Solar Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.