Today we'll look at CHTC Fong's International Company Limited (HKG:641) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 CHTC Fong's International:
0.094 = HK$192m ÷ (HK$4.8b - HK$2.7b) (Based on the trailing twelve months to December 2018.)
So, CHTC Fong's International has an ROCE of 9.4%.
Is CHTC Fong's International's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that CHTC Fong's International's ROCE is fairly close to the Machinery industry average of 11%. Setting aside the industry comparison for now, CHTC Fong's International's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
We can see that , CHTC Fong's International currently has an ROCE of 9.4% compared to its ROCE 3 years ago, which was 4.4%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how CHTC Fong's International's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. You can check if CHTC Fong's International has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect CHTC Fong's International's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
CHTC Fong's International has total assets of HK$4.8b and current liabilities of HK$2.7b. Therefore its current liabilities are equivalent to approximately 57% of its total assets. CHTC Fong's International's current liabilities are fairly high, making its ROCE look better than otherwise.
The Bottom Line On CHTC Fong's International's ROCE
Even so, the company reports a mediocre ROCE, and there may be better investments out there. You might be able to find a better investment than CHTC Fong's International. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. Thank you for reading.