How Do Xinchen China Power Holdings Limited’s (HKG:1148) Returns Compare To Its Industry?

Today we'll evaluate Xinchen China Power Holdings Limited (HKG:1148) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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'.

So, How Do We Calculate ROCE?

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 Xinchen China Power Holdings:

0.014 = CN¥55m ÷ (CN¥6.4b - CN¥2.4b) (Based on the trailing twelve months to December 2019.)

Therefore, Xinchen China Power Holdings has an ROCE of 1.4%.

View our latest analysis for Xinchen China Power Holdings

Is Xinchen China Power Holdings's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Xinchen China Power Holdings's ROCE appears to be significantly below the 12% average in the Auto Components industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Xinchen China Power Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. It is likely that there are more attractive prospects out there.

Xinchen China Power Holdings's current ROCE of 1.4% is lower than its ROCE in the past, which was 6.4%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Xinchen China Power Holdings's ROCE compares to its industry. Click to see more on past growth.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Xinchen China Power Holdings.

Do Xinchen China Power Holdings's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Xinchen China Power Holdings has current liabilities of CN¥2.4b and total assets of CN¥6.4b. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Xinchen China Power Holdings has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.

The Bottom Line On Xinchen China Power Holdings's ROCE

This company may not be the most attractive investment prospect. Of course, you might also be able to find a better stock than Xinchen China Power Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.