Today we'll look at China YuHua Education Corporation Limited (HKG:6169) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 YuHua Education:
0.14 = CN¥554m ÷ (CN¥6.1b - CN¥2.0b) (Based on the trailing twelve months to August 2018.)
Therefore, China YuHua Education has an ROCE of 14%.
Is China YuHua Education's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, China YuHua Education's ROCE is meaningfully higher than the 11% average in the Consumer Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from China YuHua Education's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
China YuHua Education's current ROCE of 14% is lower than its ROCE in the past, which was 34%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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, 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 YuHua Education.
China YuHua Education's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 YuHua Education has total liabilities of CN¥2.0b and total assets of CN¥6.1b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. China YuHua Education has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On China YuHua Education's ROCE
China YuHua Education's ROCE does look good, but the level of current liabilities also contribute to that. China YuHua Education shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.