Today we’ll look at ZK International Group Co., Ltd. (NASDAQ:ZKIN) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 ZK International Group:
0.35 = US$8.1m ÷ (US$66m – US$41m) (Based on the trailing twelve months to March 2018.)
So, ZK International Group has an ROCE of 35%.
Does ZK International Group Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, ZK International Group’s ROCE is meaningfully higher than the 10% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, ZK International Group’s ROCE currently appears to be excellent.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Given the industry it operates in, ZK International Group could be considered cyclical. You can check if ZK International Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do ZK International Group’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
ZK International Group has total assets of US$66m and current liabilities of US$41m. Therefore its current liabilities are equivalent to approximately 61% of its total assets. ZK International Group’s high level of current liabilities boost the ROCE – but its ROCE is still impressive.
The Bottom Line On ZK International Group’s ROCE
So we would be interested in doing more research here — there may be an opportunity! Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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 firstname.lastname@example.org.