In This Article:
Today we are going to look at Shandong Molong Petroleum Machinery Company Limited (HKG:568) 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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'.
How Do You Calculate Return On Capital Employed?
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 Shandong Molong Petroleum Machinery:
0.093 = CN¥227m ÷ (CN¥6.6b - CN¥4.1b) (Based on the trailing twelve months to March 2019.)
Therefore, Shandong Molong Petroleum Machinery has an ROCE of 9.3%.
Check out our latest analysis for Shandong Molong Petroleum Machinery
Is Shandong Molong Petroleum Machinery's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Shandong Molong Petroleum Machinery's ROCE is meaningfully better than the 7.5% average in the Energy Services 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. Setting aside the industry comparison for now, Shandong Molong Petroleum Machinery'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.
Shandong Molong Petroleum Machinery reported an ROCE of 9.3% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how Shandong Molong Petroleum Machinery's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Shandong Molong Petroleum Machinery could be considered a cyclical business. If Shandong Molong Petroleum Machinery is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.