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Today we'll look at Binhai Investment Company Limited (HKG:2886) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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.
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. 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 Binhai Investment:
0.10 = HK$397m ÷ (HK$6.0b - HK$2.2b) (Based on the trailing twelve months to December 2018.)
So, Binhai Investment has an ROCE of 10%.
View our latest analysis for Binhai Investment
Does Binhai Investment Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Binhai Investment's ROCE is meaningfully higher than the 8.5% average in the Gas Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Binhai Investment's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Binhai Investment's current ROCE of 10% is lower than its ROCE in the past, which was 14%, 3 years ago. So investors might consider if it has had issues recently.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Binhai Investment.