Today we are going to look at China Everbright International Limited (HKG:257) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from 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 China Everbright International:
0.10 = HK$9.1b ÷ (HK$105b - HK$17b) (Based on the trailing twelve months to June 2019.)
So, China Everbright International has an ROCE of 10%.
Is China Everbright International's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see China Everbright International's ROCE is around the 10% average reported by the Commercial Services industry. Separate from China Everbright International'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 China Everbright International's past growth compares to other companies.
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.
What Are Current Liabilities, And How Do They Affect China Everbright International'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. 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.
China Everbright International has total liabilities of HK$17b and total assets of HK$105b. Therefore its current liabilities are equivalent to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On China Everbright International's ROCE
With that in mind, China Everbright International's ROCE appears pretty good. There might be better investments than China Everbright International out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like China Everbright International 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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