Today we'll look at China Shenghai Food Holdings Company Limited (HKG:1676) and reflect on its potential as an investment. 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. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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'.
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 Shenghai Food Holdings:
0.18 = CN¥87m ÷ (CN¥516m - CN¥38m) (Based on the trailing twelve months to June 2019.)
Therefore, China Shenghai Food Holdings has an ROCE of 18%.
Does China Shenghai Food Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that China Shenghai Food Holdings's ROCE is meaningfully better than the 9.5% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from China Shenghai Food Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
China Shenghai Food Holdings's current ROCE of 18% is lower than its ROCE in the past, which was 63%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how China Shenghai Food Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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. How cyclical is China Shenghai Food Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How China Shenghai Food Holdings's Current Liabilities Impact Its 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 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 Shenghai Food Holdings has total liabilities of CN¥38m and total assets of CN¥516m. As a result, its current liabilities are equal to approximately 7.3% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), China Shenghai Food Holdings earns a sound return on capital employed.
The Bottom Line On China Shenghai Food Holdings's ROCE
If China Shenghai Food Holdings can continue reinvesting in its business, it could be an attractive prospect. China Shenghai Food Holdings 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 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 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.