In This Article:
Today we'll evaluate China Petroleum & Chemical Corporation (HKG:386) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. Overall, it is a valuable metric that has its flaws. 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'.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for China Petroleum & Chemical:
0.054 = CN¥66b ÷ (CN¥1.8t - CN¥605b) (Based on the trailing twelve months to June 2019.)
Therefore, China Petroleum & Chemical has an ROCE of 5.4%.
See our latest analysis for China Petroleum & Chemical
Does China Petroleum & Chemical Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, China Petroleum & Chemical's ROCE appears meaningfully below the 7.6% average reported by the Oil and Gas industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, China Petroleum & Chemical'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.
You can see in the image below how China Petroleum & Chemical's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, China Petroleum & Chemical could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Petroleum & Chemical.