Today we are going to look at Zhengzhou Coal Mining Machinery Group Company Limited (HKG:564) to see whether it might be an attractive investment prospect. 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. 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 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. 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?
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 Zhengzhou Coal Mining Machinery Group:
0.11 = CN¥1.9b ÷ (CN¥29b - CN¥12b) (Based on the trailing twelve months to September 2019.)
Therefore, Zhengzhou Coal Mining Machinery Group has an ROCE of 11%.
Does Zhengzhou Coal Mining Machinery Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Zhengzhou Coal Mining Machinery Group's ROCE appears to be around the 11% average of the Machinery industry. Separate from Zhengzhou Coal Mining Machinery Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Zhengzhou Coal Mining Machinery Group delivered an ROCE of 11%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. The image below shows how Zhengzhou Coal Mining Machinery Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Zhengzhou Coal Mining Machinery Group's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Zhengzhou Coal Mining Machinery Group has total assets of CN¥29b and current liabilities of CN¥12b. Therefore its current liabilities are equivalent to approximately 41% of its total assets. With this level of current liabilities, Zhengzhou Coal Mining Machinery Group's ROCE is boosted somewhat.
Our Take On Zhengzhou Coal Mining Machinery Group's ROCE
Zhengzhou Coal Mining Machinery Group's ROCE does look good, but the level of current liabilities also contribute to that. Zhengzhou Coal Mining Machinery Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.
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