Today we are going to look at China Distance Education Holdings Limited (NYSE:DL) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is 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. Overall, it is a valuable metric that has its flaws. 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?
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 Distance Education Holdings:
0.063 = US$11m ÷ (US$374m - US$196m) (Based on the trailing twelve months to June 2019.)
So, China Distance Education Holdings has an ROCE of 6.3%.
Does China Distance Education Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, China Distance Education Holdings's ROCE appears meaningfully below the 9.4% average reported by the Consumer Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how China Distance Education Holdings 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.
We can see that , China Distance Education Holdings currently has an ROCE of 6.3%, less than the 56% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how China Distance Education Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 China Distance Education Holdings.
How China Distance Education Holdings'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
China Distance Education Holdings has total assets of US$374m and current liabilities of US$196m. Therefore its current liabilities are equivalent to approximately 53% of its total assets. China Distance Education Holdings's current liabilities are fairly high, making its ROCE look better than otherwise.
What We Can Learn From China Distance Education Holdings's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might also be able to find a better stock than China Distance Education Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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. Thank you for reading.