Today we'll evaluate Shanghai Industrial Holdings Limited (HKG:363) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Shanghai Industrial Holdings:
0.07 = HK$8.3b ÷ (HK$167b - HK$50b) (Based on the trailing twelve months to December 2018.)
So, Shanghai Industrial Holdings has an ROCE of 7.0%.
Is Shanghai Industrial Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Shanghai Industrial Holdings's ROCE is meaningfully better than the 3.6% average in the Industrials 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. Aside from the industry comparison, Shanghai Industrial Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
We can see that , Shanghai Industrial Holdings currently has an ROCE of 7.0% compared to its ROCE 3 years ago, which was 4.7%. This makes us think the business might be improving. The image below shows how Shanghai Industrial Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Shanghai Industrial 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Shanghai Industrial Holdings has total liabilities of HK$50b and total assets of HK$167b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On Shanghai Industrial Holdings's ROCE
With that in mind, we're not overly impressed with Shanghai Industrial Holdings's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Shanghai Industrial Holdings. 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).
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 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.