Today we'll evaluate China Distance Education Holdings Limited (NYSE:DL) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for China Distance Education Holdings:
0.12 = US$28m ÷ (US$418m - US$189m) (Based on the trailing twelve months to December 2019.)
So, China Distance Education Holdings has an ROCE of 12%.
Does China Distance Education Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that China Distance Education Holdings's ROCE is meaningfully better than the 8.1% average in the Consumer Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how China Distance Education Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
China Distance Education Holdings's current ROCE of 12% is lower than 3 years ago, when the company reported a 67% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how China Distance Education Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Distance Education Holdings.
China Distance Education Holdings's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
China Distance Education Holdings has current liabilities of US$189m and total assets of US$418m. As a result, its current liabilities are equal to approximately 45% of its total assets. China Distance Education Holdings has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From China Distance Education Holdings's ROCE
China Distance Education Holdings's ROCE does look good, but the level of current liabilities also contribute to that. China Distance Education Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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. Thank you for reading.
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