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Today we’ll look at Shenzhen Expressway Company Limited (HKG:548) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 Shenzhen Expressway:
0.061 = CN¥2.1b ÷ (CN¥44b – CN¥5.7b) (Based on the trailing twelve months to September 2018.)
So, Shenzhen Expressway has an ROCE of 6.1%.
Check out our latest analysis for Shenzhen Expressway
Is Shenzhen Expressway’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Shenzhen Expressway’s ROCE is around the 7.1% average reported by the Infrastructure industry. Separate from how Shenzhen Expressway stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Shenzhen Expressway.
What Are Current Liabilities, And How Do They Affect Shenzhen Expressway’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.