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Are Nan Nan Resources Enterprise Limited’s (HKG:1229) High Returns Really That Great?

Today we'll look at Nan Nan Resources Enterprise Limited (HKG:1229) and reflect on its potential as an investment. 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.

First of all, we'll work out how to 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 amount of pre-tax profits a company can generate from the capital employed in its 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 Nan Nan Resources Enterprise:

0.11 = HK$25m ÷ (HK$560m - HK$342m) (Based on the trailing twelve months to September 2019.)

So, Nan Nan Resources Enterprise has an ROCE of 11%.

See our latest analysis for Nan Nan Resources Enterprise

Is Nan Nan Resources Enterprise's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Nan Nan Resources Enterprise's ROCE is meaningfully higher than the 7.8% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Nan Nan Resources Enterprise sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Nan Nan Resources Enterprise currently has an ROCE of 11%, compared to its ROCE of 9.0% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Nan Nan Resources Enterprise's past growth compares to other companies.

SEHK:1229 Past Revenue and Net Income April 9th 2020
SEHK:1229 Past Revenue and Net Income April 9th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. We note Nan Nan Resources Enterprise could be considered a cyclical business. You can check if Nan Nan Resources Enterprise has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Nan Nan Resources Enterprise's 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Nan Nan Resources Enterprise has total assets of HK$560m and current liabilities of HK$342m. Therefore its current liabilities are equivalent to approximately 61% of its total assets. Nan Nan Resources Enterprise has a relatively high level of current liabilities, boosting its ROCE meaningfully.

Our Take On Nan Nan Resources Enterprise's ROCE

This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. There might be better investments than Nan Nan Resources Enterprise 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.

I will like Nan Nan Resources Enterprise 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.