Today we'll look at Feishang Anthracite Resources Limited (HKG:1738) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, 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.
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. 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 Feishang Anthracite Resources:
0.28 = CN¥413m ÷ (CN¥3.6b - CN¥2.1b) (Based on the trailing twelve months to June 2019.)
Therefore, Feishang Anthracite Resources has an ROCE of 28%.
Is Feishang Anthracite Resources's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Feishang Anthracite Resources's ROCE is meaningfully higher than the 7.6% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Feishang Anthracite Resources's ROCE is currently very good.
Feishang Anthracite Resources has an ROCE of 28%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Feishang Anthracite Resources's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Feishang Anthracite Resources are cyclical businesses. If Feishang Anthracite Resources is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Feishang Anthracite Resources's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Feishang Anthracite Resources has total liabilities of CN¥2.1b and total assets of CN¥3.6b. Therefore its current liabilities are equivalent to approximately 59% of its total assets. Feishang Anthracite Resources's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Feishang Anthracite Resources's ROCE
In my book, this business could be worthy of further research. There might be better investments than Feishang Anthracite Resources 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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