In This Article:
Today we’ll evaluate CGN Mining Company Limited (HKG:1164) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
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. Overall, it is a valuable metric that has its flaws. 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 CGN Mining:
0.06 = HK$88m ÷ (HK$1.9b – HK$111m) (Based on the trailing twelve months to June 2018.)
So, CGN Mining has an ROCE of 6.0%.
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Does CGN Mining Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see CGN Mining’s ROCE is around the 6.0% average reported by the Trade Distributors industry. Setting aside the industry comparison for now, CGN Mining’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
CGN Mining’s current ROCE of 6.0% is lower than its ROCE in the past, which was 16%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and 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, after all, simply a snap shot of a single year. You can check if CGN Mining has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.