How Do Luoyang Glass Company Limited’s (HKG:1108) Returns Compare To Its Industry?

Simply Wall St

Mon, Apr 29, 2019, 6:39 PM

Today we are going to look at Luoyang Glass Company Limited (HKG:1108) 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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'.

How Do You Calculate Return On Capital Employed?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Luoyang Glass:

0.042 = CN¥84m ÷ (CN¥4.5b - CN¥2.5b) (Based on the trailing twelve months to December 2018.)

So, Luoyang Glass has an ROCE of 4.2%.

Check out our latest analysis for Luoyang Glass

Does Luoyang Glass Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Luoyang Glass's ROCE is meaningfully below the Building industry average of 7.1%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Luoyang Glass stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

Luoyang Glass delivered an ROCE of 4.2%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving.

SEHK:1108 Past Revenue and Net Income, April 30th 2019

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. If Luoyang Glass is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.