Today we'll evaluate Yum China Holdings, Inc. (NYSE:YUMC) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Yum China Holdings:
0.18 = US$937m ÷ (US$7.0b - US$1.7b) (Based on the trailing twelve months to December 2019.)
Therefore, Yum China Holdings has an ROCE of 18%.
Is Yum China Holdings's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Yum China Holdings's ROCE is meaningfully higher than the 8.3% average in the Hospitality 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. Independently of how Yum China Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Yum China Holdings's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Yum China 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Yum China Holdings has total assets of US$7.0b and current liabilities of US$1.7b. As a result, its current liabilities are equal to approximately 25% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Yum China Holdings's ROCE
This is good to see, and with a sound ROCE, Yum China Holdings could be worth a closer look. Yum China Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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