Today we are going to look at Yadea Group Holdings Ltd. (HKG:1585) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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.
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 Yadea Group Holdings:
0.11 = CN¥313m ÷ (CN¥7.4b - CN¥4.5b) (Based on the trailing twelve months to June 2019.)
So, Yadea Group Holdings has an ROCE of 11%.
Is Yadea Group Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Yadea Group Holdings's ROCE is meaningfully higher than the 6.4% average in the Auto industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Yadea Group Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Yadea Group Holdings's current ROCE of 11% is lower than 3 years ago, when the company reported a 23% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Yadea Group Holdings's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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, after all, simply a snap shot of a single year. How cyclical is Yadea Group Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Yadea Group Holdings's Current Liabilities Skew 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.
Yadea Group Holdings has total assets of CN¥7.4b and current liabilities of CN¥4.5b. Therefore its current liabilities are equivalent to approximately 61% of its total assets. Yadea Group Holdings's current liabilities are fairly high, which increases its ROCE significantly.
The Bottom Line On Yadea Group Holdings's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Yadea Group Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.