Today we are going to look at China Investments Holdings Limited (HKG:132) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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 'return' (pre-tax profit) a company generates from 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?
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 Investments Holdings:
0.035 = HK$111m ÷ (HK$4.6b - HK$1.5b) (Based on the trailing twelve months to June 2019.)
So, China Investments Holdings has an ROCE of 3.5%.
Does China Investments Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see China Investments Holdings's ROCE is meaningfully below the Hospitality industry average of 5.4%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside China Investments Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
China Investments Holdings delivered an ROCE of 3.5%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how China Investments Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. If China Investments Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
China Investments Holdings'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 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 Investments Holdings has total liabilities of HK$1.5b and total assets of HK$4.6b. Therefore its current liabilities are equivalent to approximately 32% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, China Investments Holdings's ROCE is concerning.
Our Take On China Investments Holdings's ROCE
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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.
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