U.S. Markets open in 4 hrs 43 mins

Should You Like CLP Holdings Limited’s (HKG:2) High Return On Capital Employed?

Simply Wall St

Today we'll look at CLP Holdings Limited (HKG:2) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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.

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 CLP Holdings:

0.084 = HK$15b ÷ (HK$222b - HK$42b) (Based on the trailing twelve months to June 2019.)

Therefore, CLP Holdings has an ROCE of 8.4%.

See our latest analysis for CLP Holdings

Is CLP Holdings's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, CLP Holdings's ROCE is meaningfully higher than the 4.9% average in the Electric Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the industry comparison for now, CLP Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

The image below shows how CLP Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:2 Past Revenue and Net Income, November 19th 2019

It is important to remember that ROCE shows past performance, and is 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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do CLP Holdings's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

CLP Holdings has total liabilities of HK$42b and total assets of HK$222b. As a result, its current liabilities are equal to approximately 19% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From CLP Holdings's ROCE

With that in mind, we're not overly impressed with CLP Holdings's ROCE, so it may not be the most appealing prospect. 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.