Why You Should Like Sinopec Shanghai Petrochemical Company Limited’s (HKG:338) ROCE

Ashwin Virk

Sun, Feb 10, 2019, 5:58 PM

Today we’ll look at Sinopec Shanghai Petrochemical Company Limited (HKG:338) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 Sinopec Shanghai Petrochemical:

0.23 = CN¥6.5b ÷ (CN¥42b – CN¥12b) (Based on the trailing twelve months to September 2018.)

Therefore, Sinopec Shanghai Petrochemical has an ROCE of 23%.

View our latest analysis for Sinopec Shanghai Petrochemical

Does Sinopec Shanghai Petrochemical Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Sinopec Shanghai Petrochemical’s ROCE is meaningfully higher than the 11% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Sinopec Shanghai Petrochemical’s ROCE is currently very good.

Our data shows that Sinopec Shanghai Petrochemical currently has an ROCE of 23%, compared to its ROCE of 10.0% 3 years ago. This makes us think the business might be improving.

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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sinopec Shanghai Petrochemical.