Why You Should Like China Railway Signal & Communication Corporation Limited’s (HKG:3969) ROCE
Today we’ll look at China Railway Signal & Communication Corporation Limited (HKG:3969) and reflect on its potential as an investment. 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, we’ll go over how we 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.
Return On Capital Employed (ROCE): What is it?
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?
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 Railway Signal & Communication:
0.16 = CN¥4.3b ÷ (CN¥72b – CN¥45b) (Based on the trailing twelve months to June 2018.)
So, China Railway Signal & Communication has an ROCE of 16%.
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Does China Railway Signal & Communication Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. China Railway Signal & Communication’s ROCE appears to be substantially greater than the 12% average in the Electronic industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how China Railway Signal & Communication compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect China Railway Signal & Communication’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
China Railway Signal & Communication has total liabilities of CN¥45b and total assets of CN¥72b. As a result, its current liabilities are equal to approximately 62% of its total assets. China Railway Signal & Communication has a relatively high level of current liabilities, boosting its ROCE meaningfully.
Our Take On China Railway Signal & Communication’s ROCE
While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. Of course you might be able to find a better stock than China Railway Signal & Communication. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like China Railway Signal & Communication better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
