Today we'll evaluate Zhengye International Holdings Company Limited (HKG:3363) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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.
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 Zhengye International Holdings:
0.12 = CN¥152m ÷ (CN¥2.4b - CN¥1.2b) (Based on the trailing twelve months to December 2019.)
So, Zhengye International Holdings has an ROCE of 12%.
Is Zhengye International Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Zhengye International Holdings's ROCE is fairly close to the Packaging industry average of 11%. Independently of how Zhengye International Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Zhengye International Holdings's current ROCE of 12% is lower than 3 years ago, when the company reported a 17% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Zhengye International Holdings's past growth compares to other companies.
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. How cyclical is Zhengye International Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Zhengye International Holdings's Current Liabilities Skew 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.
Zhengye International Holdings has total assets of CN¥2.4b and current liabilities of CN¥1.2b. Therefore its current liabilities are equivalent to approximately 47% of its total assets. With this level of current liabilities, Zhengye International Holdings's ROCE is boosted somewhat.
The Bottom Line On Zhengye International Holdings's ROCE
Zhengye International Holdings's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than Zhengye International Holdings 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 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.