Today we'll evaluate Yongsheng Advanced Materials Company Limited (HKG:3608) 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.
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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Yongsheng Advanced Materials:
0.067 = CN¥98m ÷ (CN¥1.6b - CN¥189m) (Based on the trailing twelve months to June 2019.)
So, Yongsheng Advanced Materials has an ROCE of 6.7%.
Check out our latest analysis for Yongsheng Advanced Materials
Does Yongsheng Advanced Materials Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Yongsheng Advanced Materials's ROCE is meaningfully below the Luxury industry average of 9.5%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Yongsheng Advanced Materials stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Yongsheng Advanced Materials's current ROCE of 6.7% is lower than 3 years ago, when the company reported a 18% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Yongsheng Advanced Materials's past growth compares to other companies.
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. How cyclical is Yongsheng Advanced Materials? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.