Today we'll evaluate Da Ming International Holdings Limited (HKG:1090) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. Overall, it is a valuable metric that has its flaws. 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'.
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 Da Ming International Holdings:
0.11 = CN¥435m ÷ (CN¥11b - CN¥6.9b) (Based on the trailing twelve months to June 2019.)
Therefore, Da Ming International Holdings has an ROCE of 11%.
Is Da Ming International Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Da Ming International Holdings's ROCE is meaningfully better than the 7.8% average in the Metals and Mining 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. Regardless of where Da Ming International Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Our data shows that Da Ming International Holdings currently has an ROCE of 11%, compared to its ROCE of 1.6% 3 years ago. This makes us think the business might be improving. You can see in the image below how Da Ming International Holdings's ROCE compares to its industry. Click to see more on past growth.
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. Given the industry it operates in, Da Ming International Holdings could be considered cyclical. You can check if Da Ming International Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Da Ming International Holdings's Current Liabilities And Their Impact On 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 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.
Da Ming International Holdings has current liabilities of CN¥6.9b and total assets of CN¥11b. Therefore its current liabilities are equivalent to approximately 63% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
Our Take On Da Ming International Holdings's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. Da Ming International Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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