China Futex Holdings Limited (HKG:8506) Earns A Nice Return On Capital Employed
Today we are going to look at China Futex Holdings Limited (HKG:8506) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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?
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 China Futex Holdings:
0.22 = CN¥29m ÷ (CN¥196m - CN¥64m) (Based on the trailing twelve months to June 2019.)
Therefore, China Futex Holdings has an ROCE of 22%.
See our latest analysis for China Futex Holdings
Is China Futex Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that China Futex Holdings's ROCE is meaningfully better than the 9.9% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, China Futex Holdings's ROCE currently appears to be excellent.
China Futex Holdings's current ROCE of 22% is lower than 3 years ago, when the company reported a 61% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how China Futex 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. How cyclical is China Futex Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do China Futex Holdings's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
China Futex Holdings has total liabilities of CN¥64m and total assets of CN¥196m. Therefore its current liabilities are equivalent to approximately 32% of its total assets. China Futex Holdings has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From China Futex Holdings's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than China Futex Holdings 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).
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 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. Thank you for reading.
