Today we’ll evaluate Tianjin Tianbao Energy Co., Ltd. (HKG:1671) to determine whether it could have potential as an investment idea. 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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. All else being equal, a better business will have a higher ROCE. 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 Tianjin Tianbao Energy:
0.12 = CN¥50m ÷ (CN¥602m – CN¥136m) (Based on the trailing twelve months to June 2018.)
Therefore, Tianjin Tianbao Energy has an ROCE of 12%.
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Is Tianjin Tianbao Energy’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Tianjin Tianbao Energy’s ROCE appears to be substantially greater than the 5.1% average in the Electric Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Tianjin Tianbao Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Tianjin Tianbao Energy? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Tianjin Tianbao Energy’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Tianjin Tianbao Energy has total assets of CN¥602m and current liabilities of CN¥136m. Therefore its current liabilities are equivalent to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Tianjin Tianbao Energy’s ROCE
With that in mind, Tianjin Tianbao Energy’s ROCE appears pretty good. You might be able to find a better buy 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).
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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.