Today we are going to look at Century Sunshine Group Holdings Limited (HKG:509) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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'.
How Do You Calculate Return On Capital Employed?
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 Century Sunshine Group Holdings:
0.15 = HK$775m ÷ (HK$7.5b - HK$2.3b) (Based on the trailing twelve months to December 2018.)
Therefore, Century Sunshine Group Holdings has an ROCE of 15%.
Is Century Sunshine Group Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. Century Sunshine Group Holdings's ROCE appears to be substantially greater than the 11% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Century Sunshine Group Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that , Century Sunshine Group Holdings currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 11%. This makes us think the business might be improving. You can see in the image below how Century Sunshine Group Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. If Century Sunshine Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Century Sunshine Group Holdings's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Century Sunshine Group Holdings has total assets of HK$7.5b and current liabilities of HK$2.3b. As a result, its current liabilities are equal to approximately 31% of its total assets. With this level of current liabilities, Century Sunshine Group Holdings's ROCE is boosted somewhat.
The Bottom Line On Century Sunshine Group Holdings's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Century Sunshine Group 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.