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Today we'll evaluate China Renewable Energy Investment Limited (HKG:987) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. 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?
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 Renewable Energy Investment:
0.013 = HK$29m ÷ (HK$2.5b - HK$383m) (Based on the trailing twelve months to December 2018.)
Therefore, China Renewable Energy Investment has an ROCE of 1.3%.
Is China Renewable Energy Investment's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, China Renewable Energy Investment's ROCE appears to be significantly below the 6.4% average in the Renewable Energy industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how China Renewable Energy Investment stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Our data shows that China Renewable Energy Investment currently has an ROCE of 1.3%, compared to its ROCE of 1.0% 3 years ago. This makes us wonder if the company is improving.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. ROCE is only a point-in-time measure. If China Renewable Energy Investment is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How China Renewable Energy Investment's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 Renewable Energy Investment has total assets of HK$2.5b and current liabilities of HK$383m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On China Renewable Energy Investment's ROCE
That's not a bad thing, however China Renewable Energy Investment has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like China Renewable Energy Investment better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.