Why We’re Not Impressed By Luzhou Xinglu Water (Group) Co., Ltd.’s (HKG:2281) 6.0% ROCE
Today we'll look at Luzhou Xinglu Water (Group) Co., Ltd. (HKG:2281) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Luzhou Xinglu Water (Group):
0.06 = CN¥222m ÷ (CN¥5.0b - CN¥1.3b) (Based on the trailing twelve months to June 2019.)
Therefore, Luzhou Xinglu Water (Group) has an ROCE of 6.0%.
See our latest analysis for Luzhou Xinglu Water (Group)
Is Luzhou Xinglu Water (Group)'s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Luzhou Xinglu Water (Group)'s ROCE appears to be significantly below the 7.7% average in the Water Utilities industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Luzhou Xinglu Water (Group)'s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
We can see that, Luzhou Xinglu Water (Group) currently has an ROCE of 6.0%, less than the 10.0% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Luzhou Xinglu Water (Group)'s ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. You can check if Luzhou Xinglu Water (Group) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Luzhou Xinglu Water (Group)'s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Luzhou Xinglu Water (Group) has current liabilities of CN¥1.3b and total assets of CN¥5.0b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Luzhou Xinglu Water (Group)'s ROCE
With that in mind, we're not overly impressed with Luzhou Xinglu Water (Group)'s ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Luzhou Xinglu Water (Group). So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
