Today we'll look at Xiamen International Port Co., Ltd (HKG:3378) and reflect on its potential as an investment. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
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 Xiamen International Port:
0.071 = CN¥1.1b ÷ (CN¥21b - CN¥5.6b) (Based on the trailing twelve months to December 2018.)
Therefore, Xiamen International Port has an ROCE of 7.1%.
Does Xiamen International Port Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Xiamen International Port's ROCE is around the 7.3% average reported by the Infrastructure industry. Separate from how Xiamen International Port 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.
You can see in the image below how Xiamen International Port's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Xiamen International Port.
Do Xiamen International Port'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Xiamen International Port has total liabilities of CN¥5.6b and total assets of CN¥21b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Xiamen International Port's ROCE
That said, Xiamen International Port's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Xiamen International Port. 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 firstname.lastname@example.org. 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.