Today we are going to look at Chengdu PUTIAN Telecommunications Cable Company Limited (HKG:1202) 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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. Overall, it is a valuable metric that has its flaws. 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 Chengdu PUTIAN Telecommunications Cable:
0.077 = CN¥73m ÷ (CN¥1.3b – CN¥181m) (Based on the trailing twelve months to June 2018.)
So, Chengdu PUTIAN Telecommunications Cable has an ROCE of 7.7%.
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Does Chengdu PUTIAN Telecommunications Cable Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Chengdu PUTIAN Telecommunications Cable’s ROCE is meaningfully below the Communications industry average of 14%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Chengdu PUTIAN Telecommunications Cable’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.
Chengdu PUTIAN Telecommunications Cable has an ROCE of 7.7%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. You can check if Chengdu PUTIAN Telecommunications Cable has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Chengdu PUTIAN Telecommunications Cable’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Chengdu PUTIAN Telecommunications Cable has total assets of CN¥1.3b and current liabilities of CN¥181m. As a result, its current liabilities are equal to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Chengdu PUTIAN Telecommunications Cable’s ROCE
If Chengdu PUTIAN Telecommunications Cable continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better buy than Chengdu PUTIAN Telecommunications Cable. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Chengdu PUTIAN Telecommunications Cable better if I see some big insider buys. While we wait, check out this free list 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.