Today we'll look at Clifford Modern Living Holdings Limited (HKG:3686) 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.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 Clifford Modern Living Holdings:
0.31 = CN¥101m ÷ (CN¥442m - CN¥117m) (Based on the trailing twelve months to December 2018.)
So, Clifford Modern Living Holdings has an ROCE of 31%.
Does Clifford Modern Living Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Clifford Modern Living Holdings's ROCE is meaningfully better than the 3.5% average in the Industrials industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Clifford Modern Living Holdings's ROCE currently appears to be excellent.
Clifford Modern Living Holdings's current ROCE of 31% is lower than 3 years ago, when the company reported a 55% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Clifford Modern Living Holdings's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Clifford Modern Living Holdings 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 Clifford Modern Living 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Clifford Modern Living Holdings has total liabilities of CN¥117m and total assets of CN¥442m. As a result, its current liabilities are equal to approximately 26% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Clifford Modern Living Holdings's ROCE
With low current liabilities and a high ROCE, Clifford Modern Living Holdings could be worthy of further investigation. Clifford Modern Living 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.
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 email@example.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.