Today we'll look at Chow Tai Fook Jewellery Group Limited (HKG:1929) 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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 Chow Tai Fook Jewellery Group:
0.19 = HK$6.5b ÷ (HK$62b - HK$27b) (Based on the trailing twelve months to March 2019.)
So, Chow Tai Fook Jewellery Group has an ROCE of 19%.
Does Chow Tai Fook Jewellery Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Chow Tai Fook Jewellery Group's ROCE is meaningfully better than the 14% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Chow Tai Fook Jewellery Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Chow Tai Fook Jewellery Group currently has an ROCE of 19%, compared to its ROCE of 11% 3 years ago. This makes us think the business might be improving. The image below shows how Chow Tai Fook Jewellery Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Chow Tai Fook Jewellery Group.
Chow Tai Fook Jewellery Group's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Chow Tai Fook Jewellery Group has total assets of HK$62b and current liabilities of HK$27b. As a result, its current liabilities are equal to approximately 44% of its total assets. Chow Tai Fook Jewellery Group has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Chow Tai Fook Jewellery Group's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. 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.
I will like Chow Tai Fook Jewellery Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.