Today we'll evaluate Suchuang Gas Corporation Limited (HKG:1430) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
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 Suchuang Gas:
0.082 = CN¥139m ÷ (CN¥2.1b - CN¥428m) (Based on the trailing twelve months to June 2019.)
So, Suchuang Gas has an ROCE of 8.2%.
Does Suchuang Gas Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Suchuang Gas's ROCE is around the 9.3% average reported by the Gas Utilities industry. Aside from the industry comparison, Suchuang Gas'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.
Suchuang Gas's current ROCE of 8.2% is lower than its ROCE in the past, which was 13%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Suchuang Gas's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. You can check if Suchuang Gas has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Suchuang Gas'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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Suchuang Gas has total assets of CN¥2.1b and current liabilities of CN¥428m. As a result, its current liabilities are equal to approximately 20% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Suchuang Gas's ROCE
That said, Suchuang Gas's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Suchuang Gas. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Suchuang Gas better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.