Today we are going to look at China Shanshui Cement Group Limited (HKG:691) 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 of all, we'll work out how to 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.
What is 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. All else being equal, a better business will have a higher ROCE. 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 Shanshui Cement Group:
0.30 = CN¥3.9b ÷ (CN¥26b - CN¥13b) (Based on the trailing twelve months to December 2018.)
Therefore, China Shanshui Cement Group has an ROCE of 30%.
Does China Shanshui Cement Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, China Shanshui Cement Group's ROCE is meaningfully higher than the 19% average in the Basic Materials industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, China Shanshui Cement Group's ROCE in absolute terms currently looks quite high.
China Shanshui Cement Group reported an ROCE of 30% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can see in the image below how China Shanshui Cement Group's ROCE compares to its industry. Click to see more on past growth.
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 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. If China Shanshui Cement Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect China Shanshui Cement Group's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Shanshui Cement Group has total assets of CN¥26b and current liabilities of CN¥13b. Therefore its current liabilities are equivalent to approximately 51% of its total assets. While a high level of current liabilities boosts its ROCE, China Shanshui Cement Group's returns are still very good.
The Bottom Line On China Shanshui Cement Group's ROCE
So we would be interested in doing more research here -- there may be an opportunity! China Shanshui Cement Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.