Today we'll look at China Infrastructure & Logistics Group Ltd. (HKG:1719) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 China Infrastructure & Logistics Group:
0.037 = HK$40m ÷ (HK$1.6b - HK$487m) (Based on the trailing twelve months to June 2019.)
So, China Infrastructure & Logistics Group has an ROCE of 3.7%.
Does China Infrastructure & Logistics Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see China Infrastructure & Logistics Group's ROCE is meaningfully below the Infrastructure industry average of 7.6%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how China Infrastructure & Logistics Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. Readers may wish to look for more rewarding investments.
The image below shows how China Infrastructure & Logistics Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. If China Infrastructure & Logistics Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
China Infrastructure & Logistics Group'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.
China Infrastructure & Logistics Group has total liabilities of HK$487m and total assets of HK$1.6b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, China Infrastructure & Logistics Group's ROCE is concerning.
What We Can Learn From China Infrastructure & Logistics Group's ROCE
There are likely better investments out there. Of course, you might also be able to find a better stock than China Infrastructure & Logistics Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like China Infrastructure & Logistics 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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