Here’s What Shanghai Industrial Holdings Limited’s (HKG:363) ROCE Can Tell Us
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Today we’ll look at Shanghai Industrial Holdings Limited (HKG:363) and reflect on its potential as an investment. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 Shanghai Industrial Holdings:
0.072 = HK$8.4b ÷ (HK$171b – HK$48b) (Based on the trailing twelve months to June 2018.)
So, Shanghai Industrial Holdings has an ROCE of 7.2%.
See our latest analysis for Shanghai Industrial Holdings
Does Shanghai Industrial Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Shanghai Industrial Holdings’s ROCE appears to be substantially greater than the 3.9% average in the Industrials 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. Setting aside the industry comparison for now, Shanghai Industrial Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Our data shows that Shanghai Industrial Holdings currently has an ROCE of 7.2%, compared to its ROCE of 5.3% 3 years ago. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Shanghai Industrial Holdings.
What Are Current Liabilities, And How Do They Affect Shanghai Industrial Holdings’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Shanghai Industrial Holdings has total assets of HK$171b and current liabilities of HK$48b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Shanghai Industrial Holdings’s ROCE
If Shanghai Industrial Holdings continues to earn an uninspiring ROCE, there may be better places to invest. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 editorial-team@simplywallst.com.
