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Today we’ll evaluate China Datang Corporation Renewable Power Co., Limited (HKG:1798) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 China Datang Renewable Power:
0.073 = CN¥4.0b ÷ (CN¥75b – CN¥21b) (Based on the trailing twelve months to March 2019.)
So, China Datang Renewable Power has an ROCE of 7.3%.
Is China Datang Renewable Power’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that China Datang Renewable Power’s ROCE is fairly close to the Renewable Energy industry average of 6.5%. Separate from how China Datang Renewable Power stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
As we can see, China Datang Renewable Power currently has an ROCE of 7.3% compared to its ROCE 3 years ago, which was 4.5%. This makes us think the business might be improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Datang Renewable Power.
How China Datang Renewable Power’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Datang Renewable Power has total liabilities of CN¥21b and total assets of CN¥75b. As a result, its current liabilities are equal to approximately 27% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On China Datang Renewable Power’s ROCE
With that in mind, we’re not overly impressed with China Datang Renewable Power’s ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than China Datang Renewable Power. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.com. 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.