Today we'll look at China Golden Classic Group Limited (HKG:8281) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we'll go over how we 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 China Golden Classic Group:
0.02 = CN¥4.2m ÷ (CN¥350m - CN¥143m) (Based on the trailing twelve months to September 2019.)
Therefore, China Golden Classic Group has an ROCE of 2.0%.
Does China Golden Classic Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see China Golden Classic Group's ROCE is meaningfully below the Personal Products industry average of 11%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how China Golden Classic Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. Readers may wish to look for more rewarding investments.
China Golden Classic Group's current ROCE of 2.0% is lower than its ROCE in the past, which was 17%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how China Golden Classic Group'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. 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, after all, simply a snap shot of a single year. If China Golden Classic Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How China Golden Classic Group's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
China Golden Classic Group has total liabilities of CN¥143m and total assets of CN¥350m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, China Golden Classic Group's ROCE is concerning.
The Bottom Line On China Golden Classic Group's ROCE
This company may not be the most attractive investment prospect. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org. 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.