Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we are going to look at Bao Shen Holdings Limited (HKG:8151) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Bao Shen Holdings:
0.32 = CN¥16m ÷ (CN¥132m – CN¥51m) (Based on the trailing twelve months to September 2018.)
So, Bao Shen Holdings has an ROCE of 32%.
Check out our latest analysis for Bao Shen Holdings
Is Bao Shen Holdings’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Bao Shen Holdings’s ROCE appears to be substantially greater than the 9.8% average in the Consumer Durables industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Bao Shen Holdings’s ROCE in absolute terms currently looks quite high.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 only a point-in-time measure. How cyclical is Bao Shen Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Bao Shen Holdings’s Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.