Today we'll evaluate Huadian Power International Corporation Limited (HKG:1071) 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. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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.
How Do You Calculate Return On Capital Employed?
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 Power International:
0.061 = CN¥9.6b ÷ (CN¥228b - CN¥70b) (Based on the trailing twelve months to September 2019.)
Therefore, Huadian Power International has an ROCE of 6.1%.
Is Huadian Power International's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Huadian Power International's ROCE is around the 7.1% average reported by the Renewable Energy industry. Separate from how Huadian Power International stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
Huadian Power International's current ROCE of 6.1% is lower than 3 years ago, when the company reported a 12% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Huadian Power International'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. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Huadian Power International.
Do Huadian Power International'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. 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.
Huadian Power International has total assets of CN¥228b and current liabilities of CN¥70b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Huadian Power International's ROCE is improved somewhat by its moderate amount of current liabilities.
Our Take On Huadian Power International's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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. Thank you for reading.