Today we'll evaluate E-Commodities Holdings Limited (HKG:1733) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 E-Commodities Holdings:
0.23 = HK$778m ÷ (HK$8.3b - HK$4.9b) (Based on the trailing twelve months to June 2019.)
Therefore, E-Commodities Holdings has an ROCE of 23%.
Does E-Commodities Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, E-Commodities Holdings's ROCE is meaningfully higher than the 7.6% average in the Metals and Mining 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, E-Commodities Holdings's ROCE currently appears to be excellent.
We can see that, E-Commodities Holdings currently has an ROCE of 23% compared to its ROCE 3 years ago, which was 5.2%. This makes us think the business might be improving. You can see in the image below how E-Commodities Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note E-Commodities Holdings could be considered a cyclical business. How cyclical is E-Commodities Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect E-Commodities Holdings's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.
E-Commodities Holdings has total assets of HK$8.3b and current liabilities of HK$4.9b. As a result, its current liabilities are equal to approximately 59% of its total assets. E-Commodities Holdings boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On E-Commodities Holdings's ROCE
So we would be interested in doing more research here -- there may be an opportunity! There might be better investments than E-Commodities Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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 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.
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