Today we'll look at China National Building Material Company Limited (HKG:3323) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. 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'.
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 National Building Material:
0.14 = CN¥34b ÷ (CN¥452b - CN¥212b) (Based on the trailing twelve months to June 2019.)
So, China National Building Material has an ROCE of 14%.
Does China National Building Material Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see China National Building Material's ROCE is meaningfully below the Basic Materials industry average of 18%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how China National Building Material compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, China National Building Material's ROCE appears to be 14%, compared to 3 years ago, when its ROCE was 6.1%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how China National Building Material'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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China National Building Material.
China National Building Material's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
China National Building Material has total liabilities of CN¥212b and total assets of CN¥452b. As a result, its current liabilities are equal to approximately 47% of its total assets. With this level of current liabilities, China National Building Material's ROCE is boosted somewhat.
Our Take On China National Building Material's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than China National Building Material 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 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.