A Close Look At Nine Dragons Paper (Holdings) Limited’s (HKG:2689) 20% ROCE
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Today we are going to look at Nine Dragons Paper (Holdings) Limited (HKG:2689) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the 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.
What is 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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Nine Dragons Paper (Holdings):
0.20 = CN¥11b ÷ (CN¥78b – CN¥24b) (Based on the trailing twelve months to June 2018.)
Therefore, Nine Dragons Paper (Holdings) has an ROCE of 20%.
View our latest analysis for Nine Dragons Paper (Holdings)
Does Nine Dragons Paper (Holdings) Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Nine Dragons Paper (Holdings)’s ROCE is meaningfully higher than the 10% average in the Forestry 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. Separate from Nine Dragons Paper (Holdings)’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Nine Dragons Paper (Holdings)’s ROCE appears to be 20%, compared to 3 years ago, when its ROCE was 7.0%. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Nine Dragons Paper (Holdings)’s Current Liabilities Impact 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. 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.
Nine Dragons Paper (Holdings) has total liabilities of CN¥24b and total assets of CN¥78b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. With this level of current liabilities, Nine Dragons Paper (Holdings)’s ROCE is boosted somewhat.
Our Take On Nine Dragons Paper (Holdings)’s ROCE
Nine Dragons Paper (Holdings)’s ROCE does look good, but the level of current liabilities also contribute to that. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.
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 editorial-team@simplywallst.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.
