Today we'll evaluate Ruifeng Power Group Company Limited (HKG:2025) to determine whether it could have potential as an investment idea. 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.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Ruifeng Power Group:
0.044 = CN¥44m ÷ (CN¥1.3b - CN¥317m) (Based on the trailing twelve months to December 2019.)
Therefore, Ruifeng Power Group has an ROCE of 4.4%.
Is Ruifeng Power Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Ruifeng Power Group's ROCE appears to be significantly below the 12% average in the Auto Components industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Ruifeng Power Group stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Ruifeng Power Group's current ROCE of 4.4% is lower than its ROCE in the past, which was 18%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Ruifeng Power Group's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 Ruifeng Power Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Ruifeng Power Group's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ruifeng Power Group has current liabilities of CN¥317m and total assets of CN¥1.3b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Ruifeng Power Group's ROCE
While that is good to see, Ruifeng Power Group has a low ROCE and does not look attractive in this analysis. Of course, you might also be able to find a better stock than Ruifeng Power Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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