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Today we’ll evaluate ReTo Eco-Solutions, Inc. (NASDAQ:RETO) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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’.
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 ReTo Eco-Solutions:
0.15 = US$10m ÷ (US$82m – US$20m) (Based on the trailing twelve months to June 2018.)
So, ReTo Eco-Solutions has an ROCE of 15%.
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Does ReTo Eco-Solutions Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, ReTo Eco-Solutions’s ROCE is meaningfully higher than the 9.1% average in the Basic Materials industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how ReTo Eco-Solutions compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, ReTo Eco-Solutions currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 9.2%. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 only a point-in-time measure. If ReTo Eco-Solutions is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect ReTo Eco-Solutions’s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
ReTo Eco-Solutions has total liabilities of US$20m and total assets of US$82m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On ReTo Eco-Solutions’s ROCE
This is good to see, and with a sound ROCE, ReTo Eco-Solutions could be worth a closer look. Of course you might be able to find a better stock than ReTo Eco-Solutions. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.