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Today we’ll look at COSCO SHIPPING Development Co., Ltd. (HKG:2866) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, 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.

Understanding Return On Capital Employed (ROCE)

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its 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?

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 COSCO SHIPPING Development:

0.03 = CN¥2.5b ÷ (CN¥135b – CN¥48b) (Based on the trailing twelve months to September 2018.)

Therefore, COSCO SHIPPING Development has an ROCE of 3.0%.

View our latest analysis for COSCO SHIPPING Development

Is COSCO SHIPPING Development’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see COSCO SHIPPING Development’s ROCE is around the 3.0% average reported by the Shipping industry. Independently of how COSCO SHIPPING Development compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.

As we can see, COSCO SHIPPING Development currently has an ROCE of 3.0% compared to its ROCE 3 years ago, which was 1.2%. This makes us wonder if the company is improving.

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. How cyclical is COSCO SHIPPING Development? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

COSCO SHIPPING Development’s Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

COSCO SHIPPING Development has total assets of CN¥135b and current liabilities of CN¥48b. Therefore its current liabilities are equivalent to approximately 36% of its total assets. With a medium level of current liabilities boosting the ROCE a little, COSCO SHIPPING Development’s low ROCE is unappealing.

The Bottom Line On COSCO SHIPPING Development’s ROCE

So researching other companies may be a better use of your time. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.