Today we are going to look at China Renewable Energy Investment Limited (HKG:987) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 China Renewable Energy Investment:
0.013 = HK$29m ÷ (HK$2.5b – HK$383m) (Based on the trailing twelve months to December 2018.)
Therefore, China Renewable Energy Investment has an ROCE of 1.3%.
Is China Renewable Energy Investment’s ROCE Good?
One way to assess ROCE is to compare similar companies. We can see China Renewable Energy Investment’s ROCE is meaningfully below the Renewable Energy industry average of 6.4%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how China Renewable Energy Investment compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.
In our analysis, China Renewable Energy Investment’s ROCE appears to be 1.3%, compared to 3 years ago, when its ROCE was 1.0%. This makes us think about whether the company has been reinvesting shrewdly.
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. ROCE is only a point-in-time measure. If China Renewable Energy Investment is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do China Renewable Energy Investment’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
China Renewable Energy Investment has total liabilities of HK$383m and total assets of HK$2.5b. As a result, its current liabilities are equal to approximately 15% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On China Renewable Energy Investment’s ROCE
That’s not a bad thing, however China Renewable Energy Investment has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than China Renewable Energy Investment. 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).
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.