Today we'll look at Nanfang Communication Holdings Limited (HKG:1617) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Nanfang Communication Holdings:
0.16 = CN¥136m ÷ (CN¥1.7b - CN¥861m) (Based on the trailing twelve months to June 2019.)
Therefore, Nanfang Communication Holdings has an ROCE of 16%.
Does Nanfang Communication Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Nanfang Communication Holdings's ROCE is meaningfully higher than the 11% average in the Communications industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Nanfang Communication Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how Nanfang Communication Holdings's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 Nanfang Communication Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Nanfang Communication Holdings'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Nanfang Communication Holdings has total assets of CN¥1.7b and current liabilities of CN¥861m. As a result, its current liabilities are equal to approximately 50% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
Our Take On Nanfang Communication Holdings's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Nanfang Communication 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.
I will like Nanfang Communication Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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