Today we'll look at Huarong Investment Stock Corporation Limited (HKG:2277) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Huarong Investment Stock:
0.085 = HK$596m ÷ (HK$10b - HK$3.4b) (Based on the trailing twelve months to December 2018.)
Therefore, Huarong Investment Stock has an ROCE of 8.5%.
Check out our latest analysis for Huarong Investment Stock
Is Huarong Investment Stock's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Huarong Investment Stock's ROCE appears meaningfully below the 13% average reported by the Construction industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Huarong Investment Stock's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Huarong Investment Stock's current ROCE of 8.5% is lower than 3 years ago, when the company reported a 27% ROCE. Therefore we wonder if the company is facing new headwinds.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. You can check if Huarong Investment Stock has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.