Today we are going to look at CITIC Envirotech Ltd. (SGX:CEE) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 CITIC Envirotech:
0.038 = S$115m ÷ (S$4.1b - S$1.1b) (Based on the trailing twelve months to June 2019.)
So, CITIC Envirotech has an ROCE of 3.8%.
Is CITIC Envirotech's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, CITIC Envirotech's ROCE appears meaningfully below the 5.5% average reported by the Commercial Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how CITIC Envirotech compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.3% available in government bonds. It is likely that there are more attractive prospects out there.
CITIC Envirotech's current ROCE of 3.8% is lower than its ROCE in the past, which was 8.0%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how CITIC Envirotech'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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CITIC Envirotech.
CITIC Envirotech'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
CITIC Envirotech has total assets of S$4.1b and current liabilities of S$1.1b. As a result, its current liabilities are equal to approximately 27% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
The Bottom Line On CITIC Envirotech's ROCE
CITIC Envirotech has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. Thank you for reading.