Today we are going to look at Jiashili Group Limited (HKG:1285) 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, we'll go over how we 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.
Understanding 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. Ultimately, it is a useful but imperfect metric. 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 Jiashili Group:
0.17 = CN¥162m ÷ (CN¥1.8b - CN¥820m) (Based on the trailing twelve months to June 2019.)
So, Jiashili Group has an ROCE of 17%.
Is Jiashili Group's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Jiashili Group's ROCE is meaningfully higher than the 10% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Jiashili Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how Jiashili Group'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can check if Jiashili Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Jiashili Group's Current Liabilities Impact 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.
Jiashili Group has total assets of CN¥1.8b and current liabilities of CN¥820m. As a result, its current liabilities are equal to approximately 46% of its total assets. Jiashili Group has a medium level of current liabilities, which would boost the ROCE.
Our Take On Jiashili Group's ROCE
Jiashili Group's ROCE does look good, but the level of current liabilities also contribute to that. Jiashili Group 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 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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