Today we are going to look at Li Ning Company Limited (HKG:2331) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, 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. All else being equal, a better business will have a higher ROCE. 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?
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 Li Ning:
0.16 = CN¥1.1b ÷ (CN¥11b - CN¥3.8b) (Based on the trailing twelve months to June 2019.)
So, Li Ning has an ROCE of 16%.
Does Li Ning Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Li Ning's ROCE is meaningfully higher than the 11% average in the Luxury industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Li Ning sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that , Li Ning currently has an ROCE of 16% compared to its ROCE 3 years ago, which was 6.5%. This makes us wonder if the company is improving. You can see in the image below how Li Ning'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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Li Ning's Current Liabilities And Their Impact On Its 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Li Ning has total liabilities of CN¥3.8b and total assets of CN¥11b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. With this level of current liabilities, Li Ning's ROCE is boosted somewhat.
Our Take On Li Ning's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Li Ning out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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. Thank you for reading.