Today we'll evaluate Huadian Fuxin Energy Corporation Limited (HKG:816) to determine whether it could have potential as an investment idea. 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.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Huadian Fuxin Energy:
0.066 = CN¥6.0b ÷ (CN¥109b - CN¥18b) (Based on the trailing twelve months to September 2019.)
So, Huadian Fuxin Energy has an ROCE of 6.6%.
Does Huadian Fuxin Energy Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Huadian Fuxin Energy's ROCE appears to be around the 7.1% average of the Renewable Energy industry. Separate from how Huadian Fuxin Energy stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
The image below shows how Huadian Fuxin Energy's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Huadian Fuxin Energy.
Do Huadian Fuxin Energy's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Huadian Fuxin Energy has total liabilities of CN¥18b and total assets of CN¥109b. As a result, its current liabilities are equal to approximately 16% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Huadian Fuxin Energy's ROCE
With that in mind, we're not overly impressed with Huadian Fuxin Energy's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Huadian Fuxin Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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