Why We’re Not Impressed By China Electronics Huada Technology Company Limited’s (HKG:85) 3.8% ROCE
Today we'll evaluate China Electronics Huada Technology Company Limited (HKG:85) 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?
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 Electronics Huada Technology:
0.038 = HK$80m ÷ (HK$5.0b - HK$3.0b) (Based on the trailing twelve months to June 2019.)
Therefore, China Electronics Huada Technology has an ROCE of 3.8%.
Check out our latest analysis for China Electronics Huada Technology
Is China Electronics Huada Technology's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, China Electronics Huada Technology's ROCE appears to be significantly below the 5.9% average in the Semiconductor industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how China Electronics Huada Technology stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
We can see that, China Electronics Huada Technology currently has an ROCE of 3.8% compared to its ROCE 3 years ago, which was 1.9%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how China Electronics Huada Technology'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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If China Electronics Huada Technology is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect China Electronics Huada Technology's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
China Electronics Huada Technology has total assets of HK$5.0b and current liabilities of HK$3.0b. Therefore its current liabilities are equivalent to approximately 59% of its total assets. Current liabilities of this level result in a meaningful boost to China Electronics Huada Technology's ROCE.
Our Take On China Electronics Huada Technology's ROCE
Unfortunately, its ROCE is also pretty low, so we are cautious about the stock. Of course, you might also be able to find a better stock than China Electronics Huada Technology. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
