In This Article:
Today we'll evaluate Zhongyu Gas Holdings Limited (HKG:3633) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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'.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Zhongyu Gas Holdings:
0.11 = HK$1.6b ÷ (HK$20b - HK$6.1b) (Based on the trailing twelve months to June 2019.)
So, Zhongyu Gas Holdings has an ROCE of 11%.
View our latest analysis for Zhongyu Gas Holdings
Does Zhongyu Gas Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Zhongyu Gas Holdings's ROCE is meaningfully better than the 9.4% average in the Gas Utilities 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. Regardless of where Zhongyu Gas Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how Zhongyu Gas Holdings's ROCE compares to its industry. Click to see more on past growth.
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. How cyclical is Zhongyu Gas Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Zhongyu Gas Holdings's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.