Today we'll evaluate Chinney Kin Wing Holdings Limited (HKG:1556) 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, 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Chinney Kin Wing Holdings:
0.14 = HK$64m ÷ (HK$856m - HK$386m) (Based on the trailing twelve months to June 2019.)
So, Chinney Kin Wing Holdings has an ROCE of 14%.
Does Chinney Kin Wing Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Chinney Kin Wing Holdings's ROCE appears to be around the 12% average of the Construction industry. Separate from Chinney Kin Wing Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Chinney Kin Wing Holdings's current ROCE of 14% is lower than 3 years ago, when the company reported a 40% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Chinney Kin Wing Holdings's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Chinney Kin Wing Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Chinney Kin Wing Holdings's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Chinney Kin Wing Holdings has total assets of HK$856m and current liabilities of HK$386m. As a result, its current liabilities are equal to approximately 45% of its total assets. Chinney Kin Wing Holdings has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Chinney Kin Wing Holdings's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Chinney Kin Wing Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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