Today we'll look at China Animation Characters Company Limited (HKG:1566) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 Animation Characters:
0.017 = HK$21m ÷ (HK$1.7b - HK$456m) (Based on the trailing twelve months to March 2019.)
So, China Animation Characters has an ROCE of 1.7%.
Is China Animation Characters's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, China Animation Characters's ROCE appears meaningfully below the 3.6% average reported by the Retail Distributors industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how China Animation Characters stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
China Animation Characters's current ROCE of 1.7% is lower than 3 years ago, when the company reported a 14% ROCE. So investors might consider if it has had issues recently. You can see in the image below how China Animation Characters's ROCE compares to its industry. Click to see more on 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if China Animation Characters has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect China Animation Characters's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Animation Characters has total assets of HK$1.7b and current liabilities of HK$456m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On China Animation Characters's ROCE
China Animation Characters has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than China Animation Characters. 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).
China Animation Characters is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider 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 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.