Today we are going to look at CIMC Vehicle (Group) Co., Ltd. (HKG:1839) to see whether it might be an attractive investment prospect. 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.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 CIMC Vehicle (Group):
0.20 = CN¥1.7b ÷ (CN¥17b - CN¥8.2b) (Based on the trailing twelve months to June 2019.)
Therefore, CIMC Vehicle (Group) has an ROCE of 20%.
Check out our latest analysis for CIMC Vehicle (Group)
Is CIMC Vehicle (Group)'s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. CIMC Vehicle (Group)'s ROCE appears to be substantially greater than the 9.9% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from CIMC Vehicle (Group)'s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how CIMC Vehicle (Group)'s ROCE compares to its industry. Click to see more on 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CIMC Vehicle (Group).
What Are Current Liabilities, And How Do They Affect CIMC Vehicle (Group)'s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.