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Are Xiabuxiabu Catering Management (China) Holdings Co., Ltd.’s (HKG:520) High Returns Really That Great?

Today we'll look at Xiabuxiabu Catering Management (China) Holdings Co., Ltd. (HKG:520) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Xiabuxiabu Catering Management (China) Holdings:

0.25 = CN¥554m ÷ (CN¥3.3b - CN¥994m) (Based on the trailing twelve months to December 2018.)

So, Xiabuxiabu Catering Management (China) Holdings has an ROCE of 25%.

Does Xiabuxiabu Catering Management (China) Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Xiabuxiabu Catering Management (China) Holdings's ROCE appears to be substantially greater than the 5.8% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Xiabuxiabu Catering Management (China) Holdings's ROCE currently appears to be excellent.

In our analysis, Xiabuxiabu Catering Management (China) Holdings's ROCE appears to be 25%, compared to 3 years ago, when its ROCE was 17%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Xiabuxiabu Catering Management (China) Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Xiabuxiabu Catering Management (China) Holdings.

How Xiabuxiabu Catering Management (China) Holdings'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 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.

Xiabuxiabu Catering Management (China) Holdings has total liabilities of CN¥994m and total assets of CN¥3.3b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Xiabuxiabu Catering Management (China) Holdings's ROCE is boosted somewhat by its middling amount of current liabilities.

What We Can Learn From Xiabuxiabu Catering Management (China) Holdings's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. Xiabuxiabu Catering Management (China) Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Xiabuxiabu Catering Management (China) 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.