Today we'll look at Wonderful Sky Financial Group Holdings Limited (HKG:1260) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. 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 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. 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'.
How Do You Calculate Return On Capital Employed?
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 Wonderful Sky Financial Group Holdings:
0.095 = HK$147m ÷ (HK$2.0b - HK$502m) (Based on the trailing twelve months to September 2019.)
Therefore, Wonderful Sky Financial Group Holdings has an ROCE of 9.5%.
Is Wonderful Sky Financial Group Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Wonderful Sky Financial Group Holdings's ROCE appears to be around the 9.5% average of the Media industry. Aside from the industry comparison, Wonderful Sky Financial Group Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
We can see that, Wonderful Sky Financial Group Holdings currently has an ROCE of 9.5%, less than the 18% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Wonderful Sky Financial Group Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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. If Wonderful Sky Financial Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Wonderful Sky Financial Group Holdings's 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Wonderful Sky Financial Group Holdings has total assets of HK$2.0b and current liabilities of HK$502m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On Wonderful Sky Financial Group Holdings's ROCE
With that in mind, we're not overly impressed with Wonderful Sky Financial Group Holdings's ROCE, so it may not be the most appealing prospect. 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.
There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.
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.
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