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Today we are going to look at Anxian Yuan China Holdings Limited (HKG:922) 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. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Anxian Yuan China Holdings:
0.051 = HK$53m ÷ (HK$1.1b – HK$170m) (Based on the trailing twelve months to September 2018.)
So, Anxian Yuan China Holdings has an ROCE of 5.1%.
View our latest analysis for Anxian Yuan China Holdings
Does Anxian Yuan China Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Anxian Yuan China Holdings’s ROCE is meaningfully below the Consumer Services industry average of 13%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Anxian Yuan China Holdings 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.
As we can see, Anxian Yuan China Holdings currently has an ROCE of 5.1% compared to its ROCE 3 years ago, which was 0.7%. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. If Anxian Yuan China Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.