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Why We Like Xinyi Solar Holdings Limited’s (HKG:968) 14% Return On Capital Employed

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Today we'll evaluate Xinyi Solar Holdings Limited (HKG:968) 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.

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.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from 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'.

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 Xinyi Solar Holdings:

0.14 = HK$2.5b ÷ (HK$24b - HK$6.7b) (Based on the trailing twelve months to December 2018.)

So, Xinyi Solar Holdings has an ROCE of 14%.

See our latest analysis for Xinyi Solar Holdings

Does Xinyi Solar Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Xinyi Solar Holdings's ROCE appears to be substantially greater than the 6.1% average in the Semiconductor industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Xinyi Solar Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

SEHK:968 Past Revenue and Net Income, May 7th 2019
SEHK:968 Past Revenue and Net Income, May 7th 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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Xinyi Solar Holdings's Current Liabilities Skew 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Xinyi Solar Holdings has total assets of HK$24b and current liabilities of HK$6.7b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On Xinyi Solar Holdings's ROCE

This is good to see, and with a sound ROCE, Xinyi Solar Holdings could be worth a closer look. Xinyi Solar Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like Xinyi Solar 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.

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.