Today we'll look at MOS House Group Limited (HKG:1653) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 MOS House Group:
0.11 = HK$9.5m ÷ (HK$259m - HK$171m) (Based on the trailing twelve months to March 2019.)
So, MOS House Group has an ROCE of 11%.
Is MOS House Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that MOS House Group's ROCE is fairly close to the Specialty Retail industry average of 12%. Independently of how MOS House Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
MOS House Group's current ROCE of 11% is lower than 3 years ago, when the company reported a 67% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how MOS House Group'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. How cyclical is MOS House Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
MOS House Group'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.
MOS House Group has total assets of HK$259m and current liabilities of HK$171m. Therefore its current liabilities are equivalent to approximately 66% of its total assets. MOS House Group's current liabilities are fairly high, which increases its ROCE significantly.
What We Can Learn From MOS House Group'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 MOS House Group 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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