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Is China Coal Energy Company Limited (HKG:1898) Better Than Average At Deploying Capital?

Simply Wall St

Today we'll evaluate China Coal Energy Company Limited (HKG:1898) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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?

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 Coal Energy:

0.07 = CN¥13b ÷ (CN¥272b - CN¥82b) (Based on the trailing twelve months to June 2019.)

So, China Coal Energy has an ROCE of 7.0%.

Check out our latest analysis for China Coal Energy

Does China Coal Energy Have A Good ROCE?

One way to assess ROCE is to compare similar companies. It appears that China Coal Energy's ROCE is fairly close to the Oil and Gas industry average of 7.7%. Aside from the industry comparison, China Coal Energy's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

In our analysis, China Coal Energy's ROCE appears to be 7.0%, compared to 3 years ago, when its ROCE was 0.9%. This makes us wonder if the company is improving. The image below shows how China Coal Energy's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:1898 Past Revenue and Net Income, September 9th 2019

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 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. Given the industry it operates in, China Coal Energy could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How China Coal Energy's Current Liabilities Impact 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

China Coal Energy has total liabilities of CN¥82b and total assets of CN¥272b. As a result, its current liabilities are equal to approximately 30% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

What We Can Learn From China Coal Energy's ROCE

That said, China Coal Energy's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than China Coal Energy. 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.

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 editorial-team@simplywallst.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.