Today we'll look at Chow Tai Fook Jewellery Group Limited (HKG:1929) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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 '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. Ultimately, it is a useful but imperfect metric. 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 Chow Tai Fook Jewellery Group:
0.20 = HK$5.9b ÷ (HK$64b - HK$35b) (Based on the trailing twelve months to September 2019.)
Therefore, Chow Tai Fook Jewellery Group has an ROCE of 20%.
Does Chow Tai Fook Jewellery Group Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Chow Tai Fook Jewellery Group's ROCE is meaningfully better than the 12% average in the Specialty Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Chow Tai Fook Jewellery Group's ROCE in absolute terms currently looks quite high.
Our data shows that Chow Tai Fook Jewellery Group currently has an ROCE of 20%, compared to its ROCE of 11% 3 years ago. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Chow Tai Fook Jewellery Group'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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Chow Tai Fook Jewellery Group.
What Are Current Liabilities, And How Do They Affect Chow Tai Fook Jewellery Group'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Chow Tai Fook Jewellery Group has total assets of HK$64b and current liabilities of HK$35b. As a result, its current liabilities are equal to approximately 54% of its total assets. Chow Tai Fook Jewellery Group's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Chow Tai Fook Jewellery Group's ROCE
So we would be interested in doing more research here -- there may be an opportunity! Chow Tai Fook Jewellery Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will 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 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.
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. Thank you for reading.