Why You Should Care About China Greenfresh Group Co., Ltd.’s (HKG:6183) Low Return On Capital

Today we'll look at China Greenfresh Group Co., Ltd. (HKG:6183) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?

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 Greenfresh Group:

0.051 = CN¥113m ÷ (CN¥2.4b - CN¥138m) (Based on the trailing twelve months to June 2019.)

So, China Greenfresh Group has an ROCE of 5.1%.

View our latest analysis for China Greenfresh Group

Is China Greenfresh Group's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see China Greenfresh Group's ROCE is meaningfully below the Food industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, China Greenfresh Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

China Greenfresh Group's current ROCE of 5.1% is lower than its ROCE in the past, which was 13%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how China Greenfresh Group's ROCE compares to its industry. Click to see more on past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. You can check if China Greenfresh Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do China Greenfresh Group's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

China Greenfresh Group has total liabilities of CN¥138m and total assets of CN¥2.4b. As a result, its current liabilities are equal to approximately 5.8% of its total assets. China Greenfresh Group has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

What We Can Learn From China Greenfresh Group's ROCE

If performance improves, then China Greenfresh Group may be an OK investment, especially at the right valuation. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.