Today we'll evaluate Sinofert Holdings Limited (HKG:297) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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. Then we'll determine how its current liabilities are affecting its ROCE.
What is 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Sinofert Holdings:
0.054 = CN¥425m ÷ (CN¥18b - CN¥9.9b) (Based on the trailing twelve months to June 2019.)
So, Sinofert Holdings has an ROCE of 5.4%.
Does Sinofert Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Sinofert Holdings's ROCE is meaningfully below the Chemicals industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Sinofert Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Sinofert Holdings reported an ROCE of 5.4% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. The image below shows how Sinofert Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sinofert Holdings.
Do Sinofert Holdings's Current Liabilities Skew 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. 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.
Sinofert Holdings has total liabilities of CN¥9.9b and total assets of CN¥18b. Therefore its current liabilities are equivalent to approximately 55% of its total assets. Sinofert Holdings has a fairly high level of current liabilities, meaningfully impacting its ROCE.
Our Take On Sinofert Holdings's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might also be able to find a better stock than Sinofert Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.