In This Article:
Today we are going to look at Huabao International Holdings Limited (HKG:336) to see whether it might be an attractive investment prospect. 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. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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’.
So, How Do We Calculate ROCE?
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 Huabao International Holdings:
0.11 = CN¥1.7b ÷ (CN¥18b – CN¥1.9b) (Based on the trailing twelve months to September 2018.)
Therefore, Huabao International Holdings has an ROCE of 11%.
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Is Huabao International Holdings’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Huabao International Holdings’s ROCE is around the 11% average reported by the Chemicals industry. Regardless of where Huabao International Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Huabao International Holdings’s current ROCE of 11% is lower than its ROCE in the past, which was 19%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Huabao International Holdings.