Today we'll evaluate Xiangxing International Holding Limited (HKG:1732) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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'.
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 Xiangxing International Holding:
0.33 = CN¥39m ÷ (CN¥168m - CN¥47m) (Based on the trailing twelve months to June 2019.)
Therefore, Xiangxing International Holding has an ROCE of 33%.
Is Xiangxing International Holding's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Xiangxing International Holding's ROCE appears to be substantially greater than the 3.0% average in the Shipping industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Xiangxing International Holding's ROCE is currently very good.
We can see that, Xiangxing International Holding currently has an ROCE of 33%, less than the 55% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Xiangxing International Holding's ROCE compares to its industry. Click to see more on past growth.
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. How cyclical is Xiangxing International Holding? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Xiangxing International Holding's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
Xiangxing International Holding has total assets of CN¥168m and current liabilities of CN¥47m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From Xiangxing International Holding's ROCE
With low current liabilities and a high ROCE, Xiangxing International Holding could be worthy of further investigation. There might be better investments than Xiangxing International Holding 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.
I will like Xiangxing International Holding better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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