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Today we'll look at Xiwang Special Steel Company Limited (HKG:1266) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE 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 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Xiwang Special Steel:
0.21 = CN¥1.4b ÷ (CN¥14b - CN¥7.7b) (Based on the trailing twelve months to December 2018.)
Therefore, Xiwang Special Steel has an ROCE of 21%.
View our latest analysis for Xiwang Special Steel
Does Xiwang Special Steel Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Xiwang Special Steel's ROCE appears to be substantially greater than the 9.1% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Xiwang Special Steel's ROCE currently appears to be excellent.
In our analysis, Xiwang Special Steel's ROCE appears to be 21%, compared to 3 years ago, when its ROCE was 4.8%. This makes us think about whether the company has been reinvesting shrewdly.
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 only a point-in-time measure. Given the industry it operates in, Xiwang Special Steel could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Xiwang Special Steel.