Is China Foods Limited (HKG:506) Struggling With Its 6.6% Return On Capital Employed?

Alvin Rowe

Wed, Feb 6, 2019, 7:16 PM

Today we are going to look at China Foods Limited (HKG:506) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

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. Generally speaking a higher ROCE is better. 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 China Foods:

0.066 = CN¥323m ÷ (CN¥13b – CN¥5.1b) (Based on the trailing twelve months to June 2018.)

So, China Foods has an ROCE of 6.6%.

See our latest analysis for China Foods

Is China Foods’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, China Foods’s ROCE appears to be significantly below the 11% average in the Food industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, China Foods’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.

In our analysis, China Foods’s ROCE appears to be 6.6%, compared to 3 years ago, when its ROCE was 3.7%. This makes us think about whether the company has been reinvesting shrewdly.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.