Today we'll evaluate Zhongzhi Pharmaceutical Holdings Limited (HKG:3737) to determine whether it could have potential as an investment idea. 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. 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 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. 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?
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 Zhongzhi Pharmaceutical Holdings:
0.12 = CN¥101m ÷ (CN¥1.2b - CN¥334m) (Based on the trailing twelve months to June 2019.)
Therefore, Zhongzhi Pharmaceutical Holdings has an ROCE of 12%.
Does Zhongzhi Pharmaceutical Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Zhongzhi Pharmaceutical Holdings's ROCE appears to be around the 11% average of the Personal Products industry. Separate from Zhongzhi Pharmaceutical Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Zhongzhi Pharmaceutical Holdings currently has an ROCE of 12%, compared to its ROCE of 7.6% 3 years ago. This makes us think the business might be improving. You can see in the image below how Zhongzhi Pharmaceutical Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. You can check if Zhongzhi Pharmaceutical Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Zhongzhi Pharmaceutical Holdings's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Zhongzhi Pharmaceutical Holdings has total assets of CN¥1.2b and current liabilities of CN¥334m. As a result, its current liabilities are equal to approximately 28% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Zhongzhi Pharmaceutical Holdings's ROCE
Overall, Zhongzhi Pharmaceutical Holdings has a decent ROCE and could be worthy of further research. Zhongzhi Pharmaceutical Holdings 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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. Thank you for reading.