What We Think Of Kunming Dianchi Water Treatment Co., Ltd.’s (HKG:3768) Investment Potential
Today we'll evaluate Kunming Dianchi Water Treatment Co., Ltd. (HKG:3768) 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared 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 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. 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'.
How Do You Calculate Return On Capital Employed?
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 Kunming Dianchi Water Treatment:
0.072 = CN¥535m ÷ (CN¥9.3b - CN¥1.8b) (Based on the trailing twelve months to June 2019.)
Therefore, Kunming Dianchi Water Treatment has an ROCE of 7.2%.
Check out our latest analysis for Kunming Dianchi Water Treatment
Does Kunming Dianchi Water Treatment Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Kunming Dianchi Water Treatment's ROCE is around the 7.7% average reported by the Water Utilities industry. Setting aside the industry comparison for now, Kunming Dianchi Water Treatment's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Kunming Dianchi Water Treatment's current ROCE of 7.2% is lower than 3 years ago, when the company reported a 10% ROCE. So investors might consider if it has had issues recently. The image below shows how Kunming Dianchi Water Treatment's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can check if Kunming Dianchi Water Treatment has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Kunming Dianchi Water Treatment'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Kunming Dianchi Water Treatment has total assets of CN¥9.3b and current liabilities of CN¥1.8b. Therefore its current liabilities are equivalent to approximately 20% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Kunming Dianchi Water Treatment's ROCE
That said, Kunming Dianchi Water Treatment's ROCE is mediocre, there may be more attractive investments around. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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. Thank you for reading.
