In This Article:
Today we’ll evaluate Zhongsheng Group Holdings Limited (HKG:881) to determine whether it could have potential as an investment idea. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Zhongsheng Group Holdings:
0.21 = CN¥6.4b ÷ (CN¥57b – CN¥27b) (Based on the trailing twelve months to December 2018.)
So, Zhongsheng Group Holdings has an ROCE of 21%.
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Does Zhongsheng Group Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Zhongsheng Group Holdings’s ROCE appears to be substantially greater than the 13% average in the Specialty Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Zhongsheng Group Holdings’s ROCE in absolute terms currently looks quite high.
Our data shows that Zhongsheng Group Holdings currently has an ROCE of 21%, compared to its ROCE of 11% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Zhongsheng Group Holdings.