Dongwu Cement International Limited (HKG:695) Earns A Nice Return On Capital Employed
Today we'll evaluate Dongwu Cement International Limited (HKG:695) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 Dongwu Cement International:
0.27 = CN¥139m ÷ (CN¥709m - CN¥195m) (Based on the trailing twelve months to December 2018.)
Therefore, Dongwu Cement International has an ROCE of 27%.
See our latest analysis for Dongwu Cement International
Is Dongwu Cement International's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Dongwu Cement International's ROCE is meaningfully better than the 19% average in the Basic Materials industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Dongwu Cement International's ROCE in absolute terms currently looks quite high.
Dongwu Cement International reported an ROCE of 27% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. The image below shows how Dongwu Cement International's ROCE compares to its industry, and you can click it to see more detail on its 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Dongwu Cement International? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Dongwu Cement International's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Dongwu Cement International has total liabilities of CN¥195m and total assets of CN¥709m. As a result, its current liabilities are equal to approximately 27% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From Dongwu Cement International's ROCE
This is good to see, and with such a high ROCE, Dongwu Cement International may be worth a closer look. Dongwu Cement International 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 editorial-team@simplywallst.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.
