In This Article:
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Today we'll evaluate China Energy Development Holdings Limited (HKG:228) to determine whether it could have potential as an investment idea. 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.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. Ultimately, it is a useful but imperfect metric. 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 China Energy Development Holdings:
0.13 = HK$247m ÷ (HK$2.4b - HK$550m) (Based on the trailing twelve months to December 2018.)
So, China Energy Development Holdings has an ROCE of 13%.
View our latest analysis for China Energy Development Holdings
Does China Energy Development Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, China Energy Development Holdings's ROCE is meaningfully higher than the 5.8% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from China Energy Development Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
China Energy Development Holdings reported an ROCE of 13% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. You can check if China Energy Development Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.