Today we’ll look at China Netcom Technology Holdings Limited (HKG:8071) and reflect on its potential as an investment. 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. 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?
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 China Netcom Technology Holdings:
0.34 = HK$26m ÷ (HK$108m – HK$29m) (Based on the trailing twelve months to March 2019.)
Therefore, China Netcom Technology Holdings has an ROCE of 34%.
Is China Netcom Technology Holdings’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, China Netcom Technology Holdings’s ROCE is meaningfully higher than the 7.7% average in the Software industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, China Netcom Technology Holdings’s ROCE in absolute terms currently looks quite high.
China Netcom Technology Holdings has an ROCE of 34%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. The image below shows how China Netcom Technology Holdings’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if China Netcom Technology Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect China Netcom Technology Holdings’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Netcom Technology Holdings has total assets of HK$108m and current liabilities of HK$29m. As a result, its current liabilities are equal to approximately 27% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On China Netcom Technology Holdings’s ROCE
This is good to see, and with such a high ROCE, China Netcom Technology Holdings may be worth a closer look. China Netcom Technology Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.