In This Article:
Today we'll evaluate China Leon Inspection Holding Limited (HKG:1586) 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.
First, we'll go over how we 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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 China Leon Inspection Holding:
0.068 = CN¥14m ÷ (CN¥329m - CN¥118m) (Based on the trailing twelve months to December 2018.)
So, China Leon Inspection Holding has an ROCE of 6.8%.
View our latest analysis for China Leon Inspection Holding
Does China Leon Inspection Holding Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see China Leon Inspection Holding's ROCE is around the 7.5% average reported by the Energy Services industry. Separate from how China Leon Inspection Holding stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
China Leon Inspection Holding's current ROCE of 6.8% is lower than its ROCE in the past, which was 40%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how China Leon Inspection Holding's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 only a point-in-time measure. Remember that most companies like China Leon Inspection Holding are cyclical businesses. You can check if China Leon Inspection Holding has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.