Today we’ll evaluate Tianjin Tianbao Energy Co., Ltd. (HKG:1671) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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’.
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 Tianjin Tianbao Energy:
0.081 = CN¥39m ÷ (CN¥551m – CN¥72m) (Based on the trailing twelve months to December 2018.)
Therefore, Tianjin Tianbao Energy has an ROCE of 8.1%.
Is Tianjin Tianbao Energy’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Tianjin Tianbao Energy’s ROCE is meaningfully better than the 5.2% average in the Electric Utilities 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 how Tianjin Tianbao Energy stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
As we can see, Tianjin Tianbao Energy currently has an ROCE of 8.1%, less than the 17% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Tianjin Tianbao Energy has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Tianjin Tianbao Energy’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.
Tianjin Tianbao Energy has total liabilities of CN¥72m and total assets of CN¥551m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On Tianjin Tianbao Energy’s ROCE
If Tianjin Tianbao Energy continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Tianjin Tianbao Energy. 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 Tianjin Tianbao Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.