In This Article:
Today we’ll evaluate Jiangsu Innovative Ecological New Materials Limited (HKG:2116) 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. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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?
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 Jiangsu Innovative Ecological New Materials:
0.10 = CN¥33m ÷ (CN¥263m – CN¥34m) (Based on the trailing twelve months to June 2018.)
Therefore, Jiangsu Innovative Ecological New Materials has an ROCE of 10%.
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Is Jiangsu Innovative Ecological New Materials’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Jiangsu Innovative Ecological New Materials’s ROCE appears to be around the 11% average of the Chemicals industry. Regardless of where Jiangsu Innovative Ecological New Materials sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Jiangsu Innovative Ecological New Materials’s current ROCE of 10% is lower than its ROCE in the past, which was 25%, 3 years ago. This makes us wonder if the business is facing new challenges.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 Jiangsu Innovative Ecological New Materials? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.