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

Today we’ll evaluate Xinyi Solar Holdings Limited (HKG:968) 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. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. 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.’

So, How Do We Calculate ROCE?

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:

0.18 = HK$2.9b ÷ (HK$24b – HK$7.8b) (Based on the trailing twelve months to June 2018.)

So, Xinyi Solar Holdings has an ROCE of 18%.

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Is Xinyi Solar Holdings’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Xinyi Solar Holdings’s ROCE is meaningfully higher than the 6.8% average in the Semiconductor industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Xinyi Solar Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

SEHK:968 Last Perf January 29th 19
SEHK:968 Last Perf January 29th 19

When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Xinyi Solar Holdings.

Xinyi Solar Holdings’s Current Liabilities And Their Impact On Its 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.

Xinyi Solar Holdings has total assets of HK$24b and current liabilities of HK$7.8b. Therefore its current liabilities are equivalent to approximately 32% of its total assets. With this level of current liabilities, Xinyi Solar Holdings’s ROCE is boosted somewhat.

What We Can Learn From Xinyi Solar Holdings’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. But note: Xinyi Solar Holdings 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).

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.