In This Article:
Today we’ll evaluate Hebei Yichen Industrial Group Corporation Limited (HKG:1596) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Hebei Yichen Industrial Group:
0.11 = CN¥232m ÷ (CN¥2.7b – CN¥839m) (Based on the trailing twelve months to June 2018.)
Therefore, Hebei Yichen Industrial Group has an ROCE of 11%.
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Is Hebei Yichen Industrial Group’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Hebei Yichen Industrial Group’s ROCE appears to be around the 10% average of the Machinery industry. Separate from Hebei Yichen Industrial Group’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Hebei Yichen Industrial Group’s current ROCE of 11% is lower than its ROCE in the past, which was 37%, 3 years ago. So investors might consider if it has had issues recently.
When considering this metric, keep in mind that it is backwards looking, and 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. How cyclical is Hebei Yichen Industrial Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.