Are Qilu Expressway Company Limited’s (HKG:1576) High Returns Really That Great?
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Today we are going to look at Qilu Expressway Company Limited (HKG:1576) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Qilu Expressway:
0.14 = CN¥554m ÷ (CN¥4.4b - CN¥519m) (Based on the trailing twelve months to December 2018.)
Therefore, Qilu Expressway has an ROCE of 14%.
Check out our latest analysis for Qilu Expressway
Is Qilu Expressway's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Qilu Expressway's ROCE is meaningfully better than the 7.6% average in the Infrastructure industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Qilu Expressway compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. If Qilu Expressway is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Qilu Expressway's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Qilu Expressway has total liabilities of CN¥519m and total assets of CN¥4.4b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Qilu Expressway's ROCE
This is good to see, and with a sound ROCE, Qilu Expressway could be worth a closer look. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 editorial-team@simplywallst.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.
