Today we'll look at EcoGreen International Group Limited (HKG:2341) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 EcoGreen International Group:
0.13 = CN¥377m ÷ (CN¥4.7b - CN¥1.8b) (Based on the trailing twelve months to December 2019.)
Therefore, EcoGreen International Group has an ROCE of 13%.
Does EcoGreen International Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, EcoGreen International Group's ROCE appears to be around the 12% average of the Chemicals industry. Separate from EcoGreen International Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how EcoGreen International Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If EcoGreen International Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect EcoGreen International Group'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.
EcoGreen International Group has total assets of CN¥4.7b and current liabilities of CN¥1.8b. Therefore its current liabilities are equivalent to approximately 37% of its total assets. EcoGreen International Group has a medium level of current liabilities, which would boost the ROCE.
Our Take On EcoGreen International Group's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. EcoGreen International Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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