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Today we’ll evaluate Ambow Education Holding Ltd. (NYSEMKT:AMBO) 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. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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’.
How Do You Calculate Return On Capital Employed?
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 Ambow Education Holding:
0.0078 = CN¥2.8m ÷ (CN¥983m – CN¥631m) (Based on the trailing twelve months to March 2019.)
So, Ambow Education Holding has an ROCE of 0.8%.
Is Ambow Education Holding’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Ambow Education Holding’s ROCE appears meaningfully below the 11% average reported by the Consumer Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Ambow Education Holding’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Ambow Education Holding has an ROCE of 0.8%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.
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 Ambow Education Holding? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Ambow Education Holding’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Ambow Education Holding has total liabilities of CN¥631m and total assets of CN¥983m. As a result, its current liabilities are equal to approximately 64% of its total assets. Ambow Education Holding has a fairly high level of current liabilities, boosting its ROCE.
Our Take On Ambow Education Holding’s ROCE
Ambow Education Holding’s ROCE is also pretty low (in absolute terms), making the stock look unattractive on this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.
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