Today we'll evaluate CITIC Dameng Holdings Limited (HKG:1091) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 CITIC Dameng Holdings:
0.075 = HK$330m ÷ (HK$9.9b - HK$5.5b) (Based on the trailing twelve months to June 2019.)
Therefore, CITIC Dameng Holdings has an ROCE of 7.5%.
Is CITIC Dameng Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see CITIC Dameng Holdings's ROCE is around the 8.1% average reported by the Metals and Mining industry. Separate from how CITIC Dameng Holdings 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.
CITIC Dameng Holdings delivered an ROCE of 7.5%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how CITIC Dameng Holdings's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. We note CITIC Dameng Holdings could be considered a cyclical business. How cyclical is CITIC Dameng Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How CITIC Dameng Holdings's Current Liabilities Impact 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. 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.
CITIC Dameng Holdings has total liabilities of HK$5.5b and total assets of HK$9.9b. As a result, its current liabilities are equal to approximately 56% of its total assets. CITIC Dameng Holdings has a fairly high level of current liabilities, meaningfully impacting its ROCE.
What We Can Learn From CITIC Dameng Holdings's ROCE
Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. You might be able to find a better investment than CITIC Dameng Holdings. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 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.