Today we'll look at Zhuhai Holdings Investment Group Limited (HKG:908) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
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. Ultimately, it is a useful but imperfect metric. 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 Zhuhai Holdings Investment Group:
0.11 = CN¥763m ÷ (CN¥14b - CN¥7.5b) (Based on the trailing twelve months to June 2019.)
Therefore, Zhuhai Holdings Investment Group has an ROCE of 11%.
Is Zhuhai Holdings Investment Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Zhuhai Holdings Investment Group's ROCE appears to be substantially greater than the 5.4% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Zhuhai Holdings Investment Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Zhuhai Holdings Investment Group currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 4.7%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Zhuhai Holdings Investment Group's past growth compares to other companies.
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. ROCE is only a point-in-time measure. If Zhuhai Holdings Investment Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Zhuhai Holdings Investment Group'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Zhuhai Holdings Investment Group has total liabilities of CN¥7.5b and total assets of CN¥14b. As a result, its current liabilities are equal to approximately 53% of its total assets. Zhuhai Holdings Investment Group's current liabilities are fairly high, which increases its ROCE significantly.
What We Can Learn From Zhuhai Holdings Investment Group's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. There might be better investments than Zhuhai Holdings Investment Group 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.
Zhuhai Holdings Investment Group is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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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