Today we'll evaluate China Ludao Technology Company Limited (HKG:2023) 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 up, we'll look at what ROCE is and how we calculate it. 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.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?
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 China Ludao Technology:
0.11 = CN¥47m ÷ (CN¥832m - CN¥394m) (Based on the trailing twelve months to June 2019.)
So, China Ludao Technology has an ROCE of 11%.
Does China Ludao Technology Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, China Ludao Technology's ROCE appears meaningfully below the 15% average reported by the Household Products industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from China Ludao Technology'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 China Ludao Technology currently has an ROCE of 11%, compared to its ROCE of 1.6% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how China Ludao Technology'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. ROCE is, after all, simply a snap shot of a single year. You can check if China Ludao Technology has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
China Ludao Technology's Current Liabilities And Their Impact On 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Ludao Technology has total assets of CN¥832m and current liabilities of CN¥394m. As a result, its current liabilities are equal to approximately 47% of its total assets. China Ludao Technology has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From China Ludao Technology's ROCE
China Ludao Technology's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than China Ludao Technology 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.
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.