Today we’ll look at Anhui Conch Cement Company Limited (HKG:914) 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting 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?
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 Anhui Conch Cement:
0.30 = CN¥19b ÷ (CN¥139b – CN¥24b) (Based on the trailing twelve months to September 2018.)
Therefore, Anhui Conch Cement has an ROCE of 30%.
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Is Anhui Conch Cement’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Anhui Conch Cement’s ROCE appears to be substantially greater than the 14% average in the Basic Materials 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. Regardless of the industry comparison, in absolute terms, Anhui Conch Cement’s ROCE currently appears to be excellent.
In our analysis, Anhui Conch Cement’s ROCE appears to be 30%, compared to 3 years ago, when its ROCE was 11%. This makes us think about whether the company has been reinvesting shrewdly.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Anhui Conch Cement.