Today we'll evaluate Sinotruk (Hong Kong) Limited (HKG:3808) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?
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 Sinotruk (Hong Kong):
0.20 = CN¥5.7b ÷ (CN¥62b - CN¥33b) (Based on the trailing twelve months to December 2018.)
So, Sinotruk (Hong Kong) has an ROCE of 20%.
Does Sinotruk (Hong Kong) Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Sinotruk (Hong Kong)'s ROCE is meaningfully higher than the 11% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Sinotruk (Hong Kong) compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Sinotruk (Hong Kong) currently has an ROCE of 20%, compared to its ROCE of 2.2% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Sinotruk (Hong Kong)'s ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sinotruk (Hong Kong).
How Sinotruk (Hong Kong)'s Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Sinotruk (Hong Kong) has total liabilities of CN¥33b and total assets of CN¥62b. As a result, its current liabilities are equal to approximately 53% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
Our Take On Sinotruk (Hong Kong)'s ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. There might be better investments than Sinotruk (Hong Kong) 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.