Today we’ll look at Jiancheng International Group Limited (ASX:JCI) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Jiancheng International Group:
0.20 = AU$10m ÷ (AU$81m – AU$30m) (Based on the trailing twelve months to June 2018.)
So, Jiancheng International Group has an ROCE of 20%.
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Is Jiancheng International Group’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Jiancheng International Group’s ROCE is fairly close to the Construction industry average of 23%. Independently of how Jiancheng International Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Jiancheng International Group’s current ROCE of 20% is lower than its ROCE in the past, which was 46%, 3 years ago. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and 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, after all, simply a snap shot of a single year. How cyclical is Jiancheng International Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.