In This Article:
Today we’ll evaluate Nanfang Communication Holdings Limited (HKG:1617) to determine whether it could have potential as an investment idea. 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, 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Nanfang Communication Holdings:
0.17 = CN¥119m ÷ (CN¥1.5b – CN¥674m) (Based on the trailing twelve months to June 2018.)
So, Nanfang Communication Holdings has an ROCE of 17%.
Check out our latest analysis for Nanfang Communication Holdings
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Does Nanfang Communication Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Nanfang Communication Holdings’s ROCE appears to be substantially greater than the 14% average in the Communications 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. Separate from Nanfang Communication Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Nanfang Communication Holdings.