China Feihe Limited (HKG:6186) Is Employing Capital Very Effectively

Today we'll evaluate China Feihe Limited (HKG:6186) 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.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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 Feihe:

0.31 = CN¥4.8b ÷ (CN¥23b - CN¥7.4b) (Based on the trailing twelve months to December 2019.)

So, China Feihe has an ROCE of 31%.

See our latest analysis for China Feihe

Does China Feihe Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that China Feihe's ROCE is meaningfully better than the 11% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, China Feihe's ROCE is currently very good.

We can see that, China Feihe currently has an ROCE of 31% compared to its ROCE 3 years ago, which was 15%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how China Feihe'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. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Feihe.

China Feihe's Current Liabilities And Their Impact On Its 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.

China Feihe has total assets of CN¥23b and current liabilities of CN¥7.4b. Therefore its current liabilities are equivalent to approximately 32% of its total assets. China Feihe has a medium level of current liabilities, boosting its ROCE somewhat.

Our Take On China Feihe's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. China Feihe 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.

I will like China Feihe better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.