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Today we'll evaluate Ambow Education Holding Ltd. (NYSEMKT:AMBO) to determine whether it could have potential as an investment idea. 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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?
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 Ambow Education Holding:
0.058 = CN¥15m ÷ (CN¥910m - CN¥645m) (Based on the trailing twelve months to December 2018.)
Therefore, Ambow Education Holding has an ROCE of 5.8%.
Is Ambow Education Holding's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Ambow Education Holding's ROCE appears meaningfully below the 11% average reported by the Consumer Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Ambow Education Holding stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Ambow Education Holding reported an ROCE of 5.8% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving.
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. If Ambow Education Holding is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Ambow Education Holding's Current Liabilities Impact Its 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ambow Education Holding has total assets of CN¥910m and current liabilities of CN¥645m. Therefore its current liabilities are equivalent to approximately 71% of its total assets. Ambow Education Holding's current liabilities are fairly high, making its ROCE look better than otherwise.
What We Can Learn From Ambow Education Holding's ROCE
Even so, the company reports a mediocre ROCE, and there may be better investments out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Ambow Education Holding better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.