This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Zhejiang Expressway Co Ltd (HKG:576).
Zhejiang Expressway stock represents an ownership share in the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Thus, to understand how your money can grow by investing in Zhejiang Expressway, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
ROCE: Explanation and Calculation
Choosing to invest in Zhejiang Expressway comes at the cost of investing in another potentially favourable company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. We’ll look at Zhejiang Expressway’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:
ROCE Calculation for 576
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = CN¥4.42b ÷ (CN¥75.34b – CN¥34.61b) = 10.85%
As you can see, 576 earned HK$10.9 from every HK$100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows Zhejiang Expressway is currently unable to return a desired amount to owners for the use of their capital, which isn’t favourable for investors who have forgone other potentially solid companies.
What is causing this?
Zhejiang Expressway’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Zhejiang Expressway is in an adverse position, but this can change if these factors improve. Because of this, it is important to look beyond the final value of 576’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that 576’s ROCE has deteriorated from 13.33%, indicating the company’s capital returns have declined. Over the same period, EBT went from CN¥3.57b to CN¥4.42b but capital employed rose by a relatively larger volume because of an increase in total assets and decrease in current liabilities (less borrowed money) , which suggests investor’s ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.
ROCE for 576 investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. However, it is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for 576’s future growth? Take a look at our free research report of analyst consensus for 576’s outlook.
- Valuation: What is 576 worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether 576 is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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 email@example.com.