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Today we are going to look at Maanshan Iron & Steel Company Limited (HKG:323) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Maanshan Iron & Steel:
0.25 = CN¥6.6b ÷ (CN¥74b – CN¥37b) (Based on the trailing twelve months to September 2018.)
Therefore, Maanshan Iron & Steel has an ROCE of 25%.
View our latest analysis for Maanshan Iron & Steel
Is Maanshan Iron & Steel’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Maanshan Iron & Steel’s ROCE is meaningfully higher than the 11% average in the Metals and Mining industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Maanshan Iron & Steel’s ROCE is currently very good.
Maanshan Iron & Steel reported an ROCE of 25% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Maanshan Iron & Steel could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Maanshan Iron & Steel.