Today we'll look at Alpha Era International Holdings Limited (HKG:8406) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Alpha Era International Holdings:
0.33 = CN¥31m ÷ (CN¥115m - CN¥21m) (Based on the trailing twelve months to June 2019.)
Therefore, Alpha Era International Holdings has an ROCE of 33%.
Is Alpha Era International Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Alpha Era International Holdings's ROCE appears to be substantially greater than the 8.6% average in the Leisure industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Alpha Era International Holdings's ROCE in absolute terms currently looks quite high.
You can click on the image below to see (in greater detail) how Alpha Era International Holdings's past growth compares to other companies.
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. ROCE is, after all, simply a snap shot of a single year. If Alpha Era International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Alpha Era International Holdings's Current Liabilities And Their Impact On 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Alpha Era International Holdings has total liabilities of CN¥21m and total assets of CN¥115m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Alpha Era International Holdings's ROCE
Low current liabilities and high ROCE is a good combination, making Alpha Era International Holdings look quite interesting. Alpha Era International Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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. Thank you for reading.