Today we are going to look at China Dongxiang (Group) Co., Ltd. (HKG:3818) 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. 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 '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. Ultimately, it is a useful but imperfect metric. 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?
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 Dongxiang (Group):
0.052 = CN¥553m ÷ (CN¥12b - CN¥1.1b) (Based on the trailing twelve months to March 2019.)
Therefore, China Dongxiang (Group) has an ROCE of 5.2%.
Does China Dongxiang (Group) Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, China Dongxiang (Group)'s ROCE appears to be significantly below the 11% average in the Luxury industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how China Dongxiang (Group) stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
In our analysis, China Dongxiang (Group)'s ROCE appears to be 5.2%, compared to 3 years ago, when its ROCE was 1.5%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how China Dongxiang (Group)'s past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
China Dongxiang (Group)'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 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 Dongxiang (Group) has total assets of CN¥12b and current liabilities of CN¥1.1b. As a result, its current liabilities are equal to approximately 9.6% of its total assets. With low levels of current liabilities, at least China Dongxiang (Group)'s mediocre ROCE is not unduly boosted.
The Bottom Line On China Dongxiang (Group)'s ROCE
Based on this information, China Dongxiang (Group) appears to be a mediocre business. You might be able to find a better investment than China Dongxiang (Group). 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.