Today we'll evaluate Canvest Environmental Protection Group Company Limited (HKG:1381) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. Overall, it is a valuable metric that has its flaws. 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?
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 Canvest Environmental Protection Group:
0.10 = HK$1.0b ÷ (HK$11b - HK$1.3b) (Based on the trailing twelve months to December 2018.)
So, Canvest Environmental Protection Group has an ROCE of 10%.
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Does Canvest Environmental Protection Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Canvest Environmental Protection Group's ROCE is meaningfully better than the 6.4% average in the Renewable Energy industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Canvest Environmental Protection Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Canvest Environmental Protection Group.
Canvest Environmental Protection 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Canvest Environmental Protection Group has total assets of HK$11b and current liabilities of HK$1.3b. As a result, its current liabilities are equal to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Canvest Environmental Protection Group's ROCE
Overall, Canvest Environmental Protection Group has a decent ROCE and could be worthy of further research. Canvest Environmental Protection Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.