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China Energy Development Holdings Limited (HKG:228) Earns A Nice Return On Capital Employed

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Today we'll evaluate China Energy Development Holdings Limited (HKG:228) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.

So, How Do We Calculate ROCE?

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 Energy Development Holdings:

0.13 = HK$247m ÷ (HK$2.4b - HK$550m) (Based on the trailing twelve months to December 2018.)

So, China Energy Development Holdings has an ROCE of 13%.

View our latest analysis for China Energy Development Holdings

Does China Energy Development Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, China Energy Development Holdings's ROCE is meaningfully higher than the 5.8% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from China Energy Development Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

China Energy Development Holdings reported an ROCE of 13% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability.

SEHK:228 Past Revenue and Net Income, June 10th 2019
SEHK:228 Past Revenue and Net Income, June 10th 2019

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 Energy Development Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How China Energy Development Holdings's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counter this, investors can check if a company has high current liabilities relative to total assets.

China Energy Development Holdings has total assets of HK$2.4b and current liabilities of HK$550m. As a result, its current liabilities are equal to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On China Energy Development Holdings's ROCE

This is good to see, and with a sound ROCE, China Energy Development Holdings could be worth a closer look. There might be better investments than China Energy Development Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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 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.

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