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Today we are going to look at China Aerospace International Holdings Limited (HKG:31) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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. 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?
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 Aerospace International Holdings:
0.031 = HK$409m ÷ (HK$14b – HK$1.2b) (Based on the trailing twelve months to December 2018.)
Therefore, China Aerospace International Holdings has an ROCE of 3.1%.
Is China Aerospace International Holdings’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, China Aerospace International Holdings’s ROCE appears to be significantly below the 9.9% average in the Electronic industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how China Aerospace International Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. There are potentially more appealing investments elsewhere.
Our data shows that China Aerospace International Holdings currently has an ROCE of 3.1%, compared to its ROCE of 1.5% 3 years ago. This makes us wonder if the company is improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if China Aerospace International Holdings 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 China Aerospace International Holdings’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Aerospace International Holdings has total liabilities of HK$1.2b and total assets of HK$14b. As a result, its current liabilities are equal to approximately 8.7% of its total assets. China Aerospace International Holdings has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From China Aerospace International Holdings’s ROCE
Still, investors could probably find more attractive prospects with better performance out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 firstname.lastname@example.org. 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.