Today we are going to look at Sichuan Energy Investment Development Co., Ltd. (HKG:1713) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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.
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 Sichuan Energy Investment Development:
0.064 = CN¥205m ÷ (CN¥4.4b - CN¥1.2b) (Based on the trailing twelve months to June 2019.)
Therefore, Sichuan Energy Investment Development has an ROCE of 6.4%.
Does Sichuan Energy Investment Development Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Sichuan Energy Investment Development's ROCE is meaningfully better than the 4.9% average in the Electric Utilities 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 how Sichuan Energy Investment Development stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
You can see in the image below how Sichuan Energy Investment Development's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is Sichuan Energy Investment Development? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Sichuan Energy Investment Development's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Sichuan Energy Investment Development has total assets of CN¥4.4b and current liabilities of CN¥1.2b. As a result, its current liabilities are equal to approximately 28% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Sichuan Energy Investment Development's ROCE
With that in mind, we're not overly impressed with Sichuan Energy Investment Development's ROCE, so it may not be the most appealing prospect. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.