In This Article:
Today we'll evaluate Guangshen Railway Company Limited (HKG:525) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.
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 Guangshen Railway:
0.045 = CN¥1.4b ÷ (CN¥36b - CN¥5.9b) (Based on the trailing twelve months to June 2019.)
Therefore, Guangshen Railway has an ROCE of 4.5%.
View our latest analysis for Guangshen Railway
Is Guangshen Railway's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Guangshen Railway's ROCE appears to be around the 5.0% average of the Transportation industry. Putting aside Guangshen Railway's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
We can see that, Guangshen Railway currently has an ROCE of 4.5%, less than the 6.2% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Guangshen Railway's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Guangshen Railway.
What Are Current Liabilities, And How Do They Affect Guangshen Railway's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.