Today we'll evaluate China Tian Lun Gas Holdings Limited (HKG:1600) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 China Tian Lun Gas Holdings:
0.18 = CN¥1.5b ÷ (CN¥12b - CN¥3.2b) (Based on the trailing twelve months to June 2019.)
Therefore, China Tian Lun Gas Holdings has an ROCE of 18%.
Does China Tian Lun Gas Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, China Tian Lun Gas Holdings's ROCE is meaningfully higher than the 9.4% average in the Gas Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how China Tian Lun Gas Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, China Tian Lun Gas Holdings's ROCE appears to be 18%, compared to 3 years ago, when its ROCE was 8.7%. This makes us wonder if the company is improving. The image below shows how China Tian Lun Gas Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Tian Lun Gas Holdings.
How China Tian Lun Gas Holdings'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 Tian Lun Gas Holdings has total liabilities of CN¥3.2b and total assets of CN¥12b. As a result, its current liabilities are equal to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On China Tian Lun Gas Holdings's ROCE
Overall, China Tian Lun Gas Holdings has a decent ROCE and could be worthy of further research. China Tian Lun Gas Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like China Tian Lun Gas Holdings 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 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.
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