Today we are going to look at Baidu, Inc. (NASDAQ:BIDU) to see whether it might be an attractive investment prospect. 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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.’
So, How Do We Calculate ROCE?
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 Baidu:
0.071 = CN¥17b ÷ (CN¥298b – CN¥57b) (Based on the trailing twelve months to December 2018.)
Therefore, Baidu has an ROCE of 7.1%.
Does Baidu Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Baidu’s ROCE appears to be significantly below the 10% average in the Interactive Media and Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Baidu stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Baidu’s current ROCE of 7.1% is lower than its ROCE in the past, which was 9.6%, 3 years ago. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Baidu.
What Are Current Liabilities, And How Do They Affect Baidu’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Baidu has total assets of CN¥298b and current liabilities of CN¥57b. Therefore its current liabilities are equivalent to approximately 19% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Baidu’s ROCE
That said, Baidu’s ROCE is mediocre, there may be more attractive investments around. You might be able to find a better buy than Baidu. 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.
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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.