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Why We Like China Shanshui Cement Group Limited’s (HKG:691) 29% Return On Capital Employed

Today we'll evaluate China Shanshui Cement Group Limited (HKG:691) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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.

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 Shanshui Cement Group:

0.29 = CN¥4.4b ÷ (CN¥27b - CN¥12b) (Based on the trailing twelve months to June 2019.)

Therefore, China Shanshui Cement Group has an ROCE of 29%.

See our latest analysis for China Shanshui Cement Group

Is China Shanshui Cement Group's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that China Shanshui Cement Group's ROCE is meaningfully better than the 21% average in the Basic Materials industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, China Shanshui Cement Group's ROCE currently appears to be excellent.

China Shanshui Cement Group delivered an ROCE of 29%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can click on the image below to see (in greater detail) how China Shanshui Cement Group's past growth compares to other companies.

SEHK:691 Past Revenue and Net Income, February 19th 2020
SEHK:691 Past Revenue and Net Income, February 19th 2020

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 Shanshui Cement Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How China Shanshui Cement Group's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

China Shanshui Cement Group has total assets of CN¥27b and current liabilities of CN¥12b. Therefore its current liabilities are equivalent to approximately 44% of its total assets. A medium level of current liabilities boosts China Shanshui Cement Group's ROCE somewhat.

The Bottom Line On China Shanshui Cement Group's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than China Shanshui Cement Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.