In This Article:
Today we’ll evaluate China Display Optoelectronics Technology Holdings Limited (HKG:334) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared 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 amount of pre-tax profits a company can generate from the capital employed 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’.
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 China Display Optoelectronics Technology Holdings:
0.011 = CN¥122m ÷ (CN¥2.0b – CN¥1.3b) (Based on the trailing twelve months to June 2018.)
Therefore, China Display Optoelectronics Technology Holdings has an ROCE of 1.1%.
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Is China Display Optoelectronics Technology Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see China Display Optoelectronics Technology Holdings’s ROCE is meaningfully below the Tech industry average of 5.7%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how China Display Optoelectronics Technology Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. There are potentially more appealing investments elsewhere.
China Display Optoelectronics Technology Holdings’s current ROCE of 1.1% is lower than its ROCE in the past, which was 68%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Display Optoelectronics Technology Holdings.