Today we’ll look at AviChina Industry & Technology Company Limited (HKG:2357) 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.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 AviChina Industry & Technology:
0.07 = CN¥3.0b ÷ (CN¥86b – CN¥43b) (Based on the trailing twelve months to June 2019.)
Therefore, AviChina Industry & Technology has an ROCE of 7.0%.
Check out our latest analysis for AviChina Industry & Technology
Is AviChina Industry & Technology’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, AviChina Industry & Technology’s ROCE appears to be around the 7.3% average of the Aerospace & Defense industry. Setting aside the industry comparison for now, AviChina Industry & Technology’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 AviChina Industry & Technology’s ROCE compares to its industry. Click to see more on past growth.
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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for AviChina Industry & Technology.
What Are Current Liabilities, And How Do They Affect AviChina Industry & Technology’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
AviChina Industry & Technology has current liabilities of CN¥43b and total assets of CN¥86b. As a result, its current liabilities are equal to approximately 50% of its total assets. AviChina Industry & Technology’s current liabilities are fairly high, making its ROCE look better than otherwise.
Our Take On AviChina Industry & Technology’s ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.
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