Today we are going to look at Beijing Enterprises Water Group Limited (HKG:371) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Beijing Enterprises Water Group:
0.082 = HK$7.3b ÷ (HK$126b - HK$37b) (Based on the trailing twelve months to December 2018.)
Therefore, Beijing Enterprises Water Group has an ROCE of 8.2%.
Does Beijing Enterprises Water Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Beijing Enterprises Water Group's ROCE is fairly close to the Water Utilities industry average of 7.2%. Separate from how Beijing Enterprises Water Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
You can see in the image below how Beijing Enterprises Water Group's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Beijing Enterprises Water Group's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Beijing Enterprises Water Group has total liabilities of HK$37b and total assets of HK$126b. Therefore its current liabilities are equivalent to approximately 29% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Beijing Enterprises Water Group's ROCE
That said, Beijing Enterprises Water Group's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Beijing Enterprises Water Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.