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Here’s why Tantech Holdings Ltd’s (NASDAQ:TANH) Returns On Capital Matters So Much

Seth Doty

Today we’ll evaluate Tantech Holdings Ltd (NASDAQ:TANH) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Tantech Holdings:

0.049 = US$4.6m ÷ (US$131m – US$22m) (Based on the trailing twelve months to June 2018.)

Therefore, Tantech Holdings has an ROCE of 4.9%.

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Does Tantech Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Tantech Holdings’s ROCE is meaningfully below the Chemicals industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Tantech Holdings’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

As we can see, Tantech Holdings currently has an ROCE of 4.9%, less than the 22% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.

NasdaqCM:TANH Last Perf January 18th 19

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Tantech Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Tantech Holdings’s Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.

Tantech Holdings has total liabilities of US$22m and total assets of US$131m. Therefore its current liabilities are equivalent to approximately 17% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On Tantech Holdings’s ROCE

That’s not a bad thing, however Tantech Holdings has a weak ROCE and may not be an attractive investment. Of course you might be able to find a better stock than Tantech Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Tantech Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.