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Why We’re Not Keen On CIMC-TianDa Holdings Company Limited’s (HKG:445) 6.4% Return On Capital

Simply Wall St

Today we are going to look at CIMC-TianDa Holdings Company Limited (HKG:445) to see whether it might be an attractive investment prospect. 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.

Firstly, we'll go over how we 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.

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 CIMC-TianDa Holdings:

0.064 = CN¥205m ÷ (CN¥5.9b - CN¥2.7b) (Based on the trailing twelve months to December 2018.)

So, CIMC-TianDa Holdings has an ROCE of 6.4%.

Check out our latest analysis for CIMC-TianDa Holdings

Does CIMC-TianDa Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, CIMC-TianDa Holdings's ROCE appears to be significantly below the 11% average in the Machinery 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, CIMC-TianDa Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

The image below shows how CIMC-TianDa Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:445 Past Revenue and Net Income, August 26th 2019

When considering this metric, keep in mind that it is backwards looking, and 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CIMC-TianDa Holdings.

How CIMC-TianDa Holdings'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 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.

CIMC-TianDa Holdings has total liabilities of CN¥2.7b and total assets of CN¥5.9b. As a result, its current liabilities are equal to approximately 46% of its total assets. CIMC-TianDa Holdings's middling level of current liabilities have the effect of boosting its ROCE a bit.

Our Take On CIMC-TianDa Holdings's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.

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. Thank you for reading.