In This Article:
Today we'll evaluate China Longyuan Power Group Corporation Limited (HKG:916) to determine whether it could have potential as an investment idea. 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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 Longyuan Power Group:
0.088 = CN¥9.3b ÷ (CN¥147b - CN¥40b) (Based on the trailing twelve months to March 2019.)
Therefore, China Longyuan Power Group has an ROCE of 8.8%.
See our latest analysis for China Longyuan Power Group
Is China Longyuan Power Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that China Longyuan Power Group's ROCE is meaningfully better than the 6.5% average in the Renewable Energy industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how China Longyuan Power Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
You can click on the image below to see (in greater detail) how China Longyuan Power Group's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Longyuan Power Group.