In This Article:
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Today we'll look at Towngas China Company Limited (HKG:1083) 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.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 Towngas China:
0.064 = HK$1.6b ÷ (HK$34b - HK$9.0b) (Based on the trailing twelve months to December 2018.)
Therefore, Towngas China has an ROCE of 6.4%.
Check out our latest analysis for Towngas China
Does Towngas China Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Towngas China's ROCE appears meaningfully below the 8.5% average reported by the Gas Utilities industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Towngas China's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
In our analysis, Towngas China's ROCE appears to be 6.4%, compared to 3 years ago, when its ROCE was 4.9%. 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.