In This Article:
Today we’ll look at ENN Energy Holdings Limited (HKG:2688) and reflect on its potential as an investment. 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.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?
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 ENN Energy Holdings:
0.16 = CN¥5.3b ÷ (CN¥61b – CN¥26b) (Based on the trailing twelve months to June 2018.)
Therefore, ENN Energy Holdings has an ROCE of 16%.
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Does ENN Energy Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, ENN Energy Holdings’s ROCE is meaningfully higher than the 8.9% average in the Gas Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from ENN Energy Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, ENN Energy Holdings currently has an ROCE of 16% compared to its ROCE 3 years ago, which was 13%. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for ENN Energy Holdings.