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Today we’ll evaluate China Water Affairs Group Limited (HKG:855) 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.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding 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. Generally speaking a higher ROCE is better. 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.’
How Do You Calculate Return On Capital Employed?
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 China Water Affairs Group:
0.13 = HK$2.6b ÷ (HK$32b – HK$10b) (Based on the trailing twelve months to September 2018.)
Therefore, China Water Affairs Group has an ROCE of 13%.
View our latest analysis for China Water Affairs Group
Is China Water Affairs Group’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, China Water Affairs Group’s ROCE is meaningfully higher than the 7.6% average in the Water Utilities industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from China Water Affairs Group’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, China Water Affairs Group’s ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 8.4%. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Water Affairs Group.