Tonking New Energy Group Holdings Limited (HKG:8326) Is Employing Capital Very Effectively

Simply Wall St

Today we are going to look at Tonking New Energy Group Holdings Limited (HKG:8326) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

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 Tonking New Energy Group Holdings:

0.25 = HK$55m ÷ (HK$617m - HK$398m) (Based on the trailing twelve months to December 2018.)

So, Tonking New Energy Group Holdings has an ROCE of 25%.

Check out our latest analysis for Tonking New Energy Group Holdings

Is Tonking New Energy Group Holdings's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Tonking New Energy Group Holdings's ROCE is meaningfully higher than the 5.7% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Tonking New Energy Group Holdings's ROCE in absolute terms currently looks quite high.

Tonking New Energy Group Holdings delivered an ROCE of 25%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.

SEHK:8326 Past Revenue and Net Income, April 19th 2019
SEHK:8326 Past Revenue and Net Income, April 19th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. How cyclical is Tonking New Energy Group Holdings? 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 Tonking New Energy Group Holdings's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Tonking New Energy Group Holdings has total liabilities of HK$398m and total assets of HK$617m. Therefore its current liabilities are equivalent to approximately 65% of its total assets. Tonking New Energy Group Holdings's high level of current liabilities boost the ROCE - but its ROCE is still impressive.

What We Can Learn From Tonking New Energy Group Holdings's ROCE

So to us, the company is potentially worth investigating further. Tonking New Energy Group Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.