Today we are going to look at Qingling Motors Co., Ltd. (HKG:1122) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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'.
So, How Do We Calculate ROCE?
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 Qingling Motors:
0.03 = CN¥242m ÷ (CN¥11b - CN¥2.7b) (Based on the trailing twelve months to June 2019.)
Therefore, Qingling Motors has an ROCE of 3.0%.
Is Qingling Motors's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Qingling Motors's ROCE appears to be significantly below the 6.4% average in the Auto industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Qingling Motors's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Qingling Motors's current ROCE of 3.0% is lower than 3 years ago, when the company reported a 5.2% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Qingling Motors'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. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Qingling Motors is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Qingling Motors's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Qingling Motors has total liabilities of CN¥2.7b and total assets of CN¥11b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
The Bottom Line On Qingling Motors's ROCE
That's not a bad thing, however Qingling Motors has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than Qingling Motors. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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. Thank you for reading.