In This Article:
Today we are going to look at Huajin International Holdings Limited (HKG:2738) 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, 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.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Huajin International Holdings:
0.12 = CN¥74m ÷ (CN¥1.8b - CN¥1.1b) (Based on the trailing twelve months to December 2018.)
Therefore, Huajin International Holdings has an ROCE of 12%.
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Does Huajin International Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Huajin International Holdings's ROCE is meaningfully better than the 9.0% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Huajin International Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Huajin International Holdings's current ROCE of 12% is lower than 3 years ago, when the company reported a 48% ROCE. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. We note Huajin International Holdings could be considered a cyclical business. If Huajin International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.