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Geely Automobile Holdings Limited (HKG:175) Is Employing Capital Very Effectively

Simply Wall St

Today we'll look at Geely Automobile Holdings Limited (HKG:175) 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.

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. 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.'

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 Geely Automobile Holdings:

0.28 = CN¥13b ÷ (CN¥91b - CN¥44b) (Based on the trailing twelve months to December 2018.)

So, Geely Automobile Holdings has an ROCE of 28%.

See our latest analysis for Geely Automobile Holdings

Does Geely Automobile Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Geely Automobile Holdings's ROCE is meaningfully better than the 5.1% average in the Auto industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Geely Automobile Holdings's ROCE currently appears to be excellent.

In our analysis, Geely Automobile Holdings's ROCE appears to be 28%, compared to 3 years ago, when its ROCE was 7.6%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Geely Automobile Holdings's ROCE compares to its industry. Click to see more on past growth.

SEHK:175 Past Revenue and Net Income, July 25th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Geely Automobile Holdings.

How Geely Automobile Holdings's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.

Geely Automobile Holdings has total assets of CN¥91b and current liabilities of CN¥44b. Therefore its current liabilities are equivalent to approximately 48% of its total assets. Geely Automobile Holdings has a medium level of current liabilities, boosting its ROCE somewhat.

The Bottom Line On Geely Automobile Holdings's ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. There might be better investments than Geely Automobile Holdings 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.

I will like Geely Automobile Holdings 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 editorial-team@simplywallst.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.