Today we'll evaluate SPT Energy Group Inc. (HKG:1251) 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?
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 SPT Energy Group:
0.14 = CN¥203m ÷ (CN¥2.5b - CN¥1.1b) (Based on the trailing twelve months to June 2019.)
So, SPT Energy Group has an ROCE of 14%.
Does SPT Energy Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see SPT Energy Group's ROCE is around the 13% average reported by the Energy Services industry. Independently of how SPT Energy Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
SPT Energy Group reported an ROCE of 14% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how SPT Energy Group's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. We note SPT Energy Group could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do SPT Energy Group'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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
SPT Energy Group has total assets of CN¥2.5b and current liabilities of CN¥1.1b. Therefore its current liabilities are equivalent to approximately 42% of its total assets. SPT Energy Group has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On SPT Energy Group's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than SPT Energy Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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. Thank you for reading.