Today we'll look at COSCO SHIPPING Holdings Co., Ltd. (HKG:1919) and reflect on its potential as an investment. 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 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.

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. Generally speaking a higher ROCE is better. 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 COSCO SHIPPING Holdings:

0.027 = CN¥4.4b ÷ (CN¥256b - CN¥90b) (Based on the trailing twelve months to March 2019.)

Therefore, COSCO SHIPPING Holdings has an ROCE of 2.7%.

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Does COSCO SHIPPING Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see COSCO SHIPPING Holdings's ROCE is around the 3.1% average reported by the Shipping industry. Independently of how COSCO SHIPPING Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. Readers may wish to look for more rewarding investments.

COSCO SHIPPING Holdings has an ROCE of 2.7%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.

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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for COSCO SHIPPING Holdings.

COSCO SHIPPING Holdings's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 Holdings has total liabilities of CN¥90b and total assets of CN¥256b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. With a medium level of current liabilities boosting the ROCE a little, COSCO SHIPPING Holdings's low ROCE is unappealing.

What We Can Learn From COSCO SHIPPING Holdings's ROCE

This company may not be the most attractive investment prospect. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.