Today we are going to look at Changshouhua Food Company Limited (HKG:1006) 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Changshouhua Food:
0.099 = CN¥330m ÷ (CN¥3.9b - CN¥528m) (Based on the trailing twelve months to December 2019.)
So, Changshouhua Food has an ROCE of 9.9%.
Is Changshouhua Food's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Changshouhua Food's ROCE appears to be around the 10% average of the Food industry. Separate from Changshouhua Food's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how Changshouhua Food's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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, after all, simply a snap shot of a single year. How cyclical is Changshouhua Food? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Changshouhua Food's Current Liabilities And Their Impact On 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Changshouhua Food has total assets of CN¥3.9b and current liabilities of CN¥528m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Changshouhua Food's ROCE
This is good to see, and with a sound ROCE, Changshouhua Food could be worth a closer look. Changshouhua Food 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.
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