Today we’ll look at Henan Jinma Energy Company Limited (HKG:6885) and reflect on its potential as an investment. 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. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.’
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 Henan Jinma Energy:
0.45 = CN¥1.2b ÷ (CN¥4.1b – CN¥1.4b) (Based on the trailing twelve months to December 2018.)
Therefore, Henan Jinma Energy has an ROCE of 45%.
Is Henan Jinma Energy’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Henan Jinma Energy’s ROCE is meaningfully higher than the 11% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Henan Jinma Energy’s ROCE in absolute terms currently looks quite high.
Our data shows that Henan Jinma Energy currently has an ROCE of 45%, compared to its ROCE of 9.5% 3 years ago. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is 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. Given the industry it operates in, Henan Jinma Energy could be considered cyclical. If Henan Jinma Energy is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Henan Jinma Energy’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.
Henan Jinma Energy has total liabilities of CN¥1.4b and total assets of CN¥4.1b. As a result, its current liabilities are equal to approximately 35% of its total assets. Henan Jinma Energy has a medium level of current liabilities, boosting its ROCE somewhat.
The Bottom Line On Henan Jinma Energy’s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. You might be able to find a better buy than Henan Jinma Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.