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Today we’ll look at Xinghua Port Holdings Ltd. (HKG:1990) 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.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
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. 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’.
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 Xinghua Port Holdings:
0.11 = CN¥176m ÷ (CN¥1.7b – CN¥244m) (Based on the trailing twelve months to June 2018.)
Therefore, Xinghua Port Holdings has an ROCE of 11%.
Check out our latest analysis for Xinghua Port Holdings
Is Xinghua Port Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. Xinghua Port Holdings’s ROCE appears to be substantially greater than the 7.1% average in the Infrastructure industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Xinghua Port Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, Xinghua Port Holdings currently has an ROCE of 11%, less than the 16% it reported 3 years ago. 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. ROCE is, after all, simply a snap shot of a single year. You can check if Xinghua Port Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.