Today we'll evaluate Shinelong Automotive Lightweight Application Limited (HKG:1930) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. 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?
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 Shinelong Automotive Lightweight Application:
0.12 = CN¥29m ÷ (CN¥439m - CN¥185m) (Based on the trailing twelve months to June 2019.)
So, Shinelong Automotive Lightweight Application has an ROCE of 12%.
Does Shinelong Automotive Lightweight Application Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Shinelong Automotive Lightweight Application's ROCE appears to be around the 11% average of the Auto Components industry. Separate from Shinelong Automotive Lightweight Application'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 Shinelong Automotive Lightweight Application's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. You can check if Shinelong Automotive Lightweight Application has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Shinelong Automotive Lightweight Application's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Shinelong Automotive Lightweight Application has total liabilities of CN¥185m and total assets of CN¥439m. Therefore its current liabilities are equivalent to approximately 42% of its total assets. Shinelong Automotive Lightweight Application has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Shinelong Automotive Lightweight Application's ROCE
Shinelong Automotive Lightweight Application's ROCE does look good, but the level of current liabilities also contribute to that. Shinelong Automotive Lightweight Application 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.
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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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Thank you for reading.