Today we'll look at Dongwu Cement International Limited (HKG:695) 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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 Dongwu Cement International:
0.25 = CN¥140m ÷ (CN¥774m - CN¥221m) (Based on the trailing twelve months to June 2019.)
Therefore, Dongwu Cement International has an ROCE of 25%.
Does Dongwu Cement International Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Dongwu Cement International's ROCE appears to be substantially greater than the 21% average in the Basic Materials industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Dongwu Cement International's ROCE in absolute terms currently looks quite high.
Dongwu Cement International delivered an ROCE of 25%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how Dongwu Cement International'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. 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. How cyclical is Dongwu Cement International? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Dongwu Cement International's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Dongwu Cement International has current liabilities of CN¥221m and total assets of CN¥774m. Therefore its current liabilities are equivalent to approximately 29% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
Our Take On Dongwu Cement International's ROCE
Low current liabilities and high ROCE is a good combination, making Dongwu Cement International look quite interesting. There might be better investments than Dongwu Cement 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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