Today we are going to look at Churchill China plc (LON:CHH) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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'.
So, How Do We Calculate ROCE?
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 Churchill China:
0.20 = UK£9.0m ÷ (UK£55m - UK£11m) (Based on the trailing twelve months to December 2018.)
So, Churchill China has an ROCE of 20%.
Does Churchill China Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Churchill China's ROCE is meaningfully higher than the 15% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Churchill China's ROCE is currently very good.
We can see that , Churchill China currently has an ROCE of 20% compared to its ROCE 3 years ago, which was 13%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Churchill China's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. If Churchill China is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Churchill China's Current Liabilities And Their Impact On 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Churchill China has total liabilities of UK£11m and total assets of UK£55m. As a result, its current liabilities are equal to approximately 19% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
What We Can Learn From Churchill China's ROCE
This is good to see, and with such a high ROCE, Churchill China may be worth a closer look. Churchill China looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.