Today we'll evaluate Putian Communication Group Limited (HKG:1720) 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.
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 Putian Communication Group:
0.17 = CN¥96m ÷ (CN¥733m - CN¥166m) (Based on the trailing twelve months to June 2019.)
So, Putian Communication Group has an ROCE of 17%.
Does Putian Communication Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Putian Communication Group's ROCE is meaningfully better than the 9.0% average in the Communications industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Putian Communication Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Putian Communication Group's current ROCE of 17% is lower than 3 years ago, when the company reported a 27% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Putian Communication Group's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. How cyclical is Putian Communication Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Putian Communication Group's Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Putian Communication Group has current liabilities of CN¥166m and total assets of CN¥733m. As a result, its current liabilities are equal to approximately 23% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Putian Communication Group's ROCE
This is good to see, and with a sound ROCE, Putian Communication Group could be worth a closer look. Putian Communication Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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