Today we'll look at China Chengtong Development Group Limited (HKG:217) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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'.
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 Chengtong Development Group:
0.00039 = HK$1.2m ÷ (HK$3.6b - HK$528m) (Based on the trailing twelve months to June 2019.)
Therefore, China Chengtong Development Group has an ROCE of 0.04%.
Does China Chengtong Development Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, China Chengtong Development Group's ROCE appears meaningfully below the 7.6% average reported by the Trade Distributors industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how China Chengtong Development Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. It is likely that there are more attractive prospects out there.
We can see that, China Chengtong Development Group currently has an ROCE of 0.04%, less than the 0.9% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how China Chengtong Development Group'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If China Chengtong Development Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
China Chengtong Development Group's Current Liabilities And Their Impact On Its 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Chengtong Development Group has total liabilities of HK$528m and total assets of HK$3.6b. As a result, its current liabilities are equal to approximately 15% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On China Chengtong Development Group's ROCE
That's not a bad thing, however China Chengtong Development Group has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than China Chengtong Development Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.