Today we'll evaluate Zhaojin Mining Industry Company Limited (HKG:1818) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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'.
So, How Do We Calculate ROCE?
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 Zhaojin Mining Industry:
0.026 = CN¥673m ÷ (CN¥39b - CN¥13b) (Based on the trailing twelve months to June 2019.)
So, Zhaojin Mining Industry has an ROCE of 2.6%.
Does Zhaojin Mining Industry Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Zhaojin Mining Industry's ROCE appears meaningfully below the 8.1% average reported by the Metals and Mining industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Zhaojin Mining Industry stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Zhaojin Mining Industry's current ROCE of 2.6% is lower than its ROCE in the past, which was 4.1%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Zhaojin Mining Industry'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. We note Zhaojin Mining Industry could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Zhaojin Mining Industry.
What Are Current Liabilities, And How Do They Affect Zhaojin Mining Industry's 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 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.
Zhaojin Mining Industry has total liabilities of CN¥13b and total assets of CN¥39b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. Zhaojin Mining Industry has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.
What We Can Learn From Zhaojin Mining Industry's ROCE
This company may not be the most attractive investment prospect. 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 firstname.lastname@example.org. 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.