Today we'll evaluate China Greenland Broad Greenstate Group Company Limited (HKG:1253) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. 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 China Greenland Broad Greenstate Group:
0.052 = CN¥48m ÷ (CN¥3.4b - CN¥2.4b) (Based on the trailing twelve months to December 2019.)
Therefore, China Greenland Broad Greenstate Group has an ROCE of 5.2%.
Is China Greenland Broad Greenstate Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, China Greenland Broad Greenstate Group's ROCE appears to be significantly below the 13% average in the Commercial Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, China Greenland Broad Greenstate Group'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.
We can see that, China Greenland Broad Greenstate Group currently has an ROCE of 5.2%, less than the 33% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how China Greenland Broad Greenstate Group'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 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. How cyclical is China Greenland Broad Greenstate Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect China Greenland Broad Greenstate Group's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
China Greenland Broad Greenstate Group has current liabilities of CN¥2.4b and total assets of CN¥3.4b. Therefore its current liabilities are equivalent to approximately 73% of its total assets. China Greenland Broad Greenstate Group's current liabilities are fairly high, making its ROCE look better than otherwise.
What We Can Learn From China Greenland Broad Greenstate Group's ROCE
Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. Of course, you might also be able to find a better stock than China Greenland Broad Greenstate Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like China Greenland Broad Greenstate Group 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 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.
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