Today we'll look at Kwoon Chung Bus Holdings Limited (HKG:306) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. 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'.
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 Kwoon Chung Bus Holdings:
0.082 = HK$266m ÷ (HK$5.3b - HK$2.1b) (Based on the trailing twelve months to March 2019.)
Therefore, Kwoon Chung Bus Holdings has an ROCE of 8.2%.
Does Kwoon Chung Bus Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Kwoon Chung Bus Holdings's ROCE is meaningfully higher than the 5.0% average in the Transportation industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Aside from the industry comparison, Kwoon Chung Bus Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
We can see that , Kwoon Chung Bus Holdings currently has an ROCE of 8.2%, less than the 13% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Kwoon Chung Bus Holdings's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. If Kwoon Chung Bus Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Kwoon Chung Bus Holdings's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Kwoon Chung Bus Holdings has total assets of HK$5.3b and current liabilities of HK$2.1b. Therefore its current liabilities are equivalent to approximately 39% of its total assets. Kwoon Chung Bus Holdings has a medium level of current liabilities, which would boost its ROCE somewhat.
Our Take On Kwoon Chung Bus Holdings's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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.