Today we'll look at HengTen Networks Group Limited (HKG:136) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 HengTen Networks Group:
0.056 = CN¥64m ÷ (CN¥1.5b - CN¥390m) (Based on the trailing twelve months to December 2019.)
Therefore, HengTen Networks Group has an ROCE of 5.6%.
Is HengTen Networks Group's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, HengTen Networks Group's ROCE is meaningfully higher than the 4.5% average in the Online Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how HengTen Networks Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
We can see that, HengTen Networks Group currently has an ROCE of 5.6% compared to its ROCE 3 years ago, which was 0.7%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how HengTen Networks Group's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. How cyclical is HengTen Networks Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How HengTen Networks Group's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
HengTen Networks Group has current liabilities of CN¥390m and total assets of CN¥1.5b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On HengTen Networks Group's ROCE
That said, HengTen Networks Group's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than HengTen Networks Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like HengTen Networks 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 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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