Today we'll evaluate Tongcheng-Elong Holdings Limited (HKG:780) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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 Tongcheng-Elong Holdings:
0.06 = CN¥815m ÷ (CN¥19b - CN¥5.7b) (Based on the trailing twelve months to September 2019.)
Therefore, Tongcheng-Elong Holdings has an ROCE of 6.0%.
Does Tongcheng-Elong Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Tongcheng-Elong Holdings's ROCE appears meaningfully below the 8.9% average reported by the Online Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Tongcheng-Elong 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.
Tongcheng-Elong Holdings delivered an ROCE of 6.0%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how Tongcheng-Elong Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Tongcheng-Elong Holdings.
How Tongcheng-Elong Holdings's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Tongcheng-Elong Holdings has total assets of CN¥19b and current liabilities of CN¥5.7b. Therefore its current liabilities are equivalent to approximately 29% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On Tongcheng-Elong Holdings's ROCE
That said, Tongcheng-Elong Holdings's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Tongcheng-Elong Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Tongcheng-Elong Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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