Today we are going to look at China Dongxiang (Group) Co., Ltd. (HKG:3818) to see whether it might be an attractive investment prospect. 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. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from 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?
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 China Dongxiang (Group):
0.048 = CN¥483m ÷ (CN¥12b – CN¥1.6b) (Based on the trailing twelve months to December 2018.)
Therefore, China Dongxiang (Group) has an ROCE of 4.8%.
Does China Dongxiang (Group) Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see China Dongxiang (Group)’s ROCE is meaningfully below the Luxury industry average of 9.5%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside China Dongxiang (Group)’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
In our analysis, China Dongxiang (Group)’s ROCE appears to be 4.8%, compared to 3 years ago, when its ROCE was 1.5%. This makes us wonder if the company is improving.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do China Dongxiang (Group)’s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
China Dongxiang (Group) has total liabilities of CN¥1.6b and total assets of CN¥12b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On China Dongxiang (Group)’s ROCE
That’s not a bad thing, however China Dongxiang (Group) has a weak ROCE and may not be an attractive investment. You might be able to find a better buy than China Dongxiang (Group). If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like China Dongxiang (Group) 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 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. Thank you for reading.