Today we'll evaluate Wing Fung Group Asia Limited (HKG:8526) to determine whether it could have potential as an investment idea. 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.
Return On Capital Employed (ROCE): What is it?
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. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Wing Fung Group Asia:
0.20 = HK$18m ÷ (HK$141m - HK$50m) (Based on the trailing twelve months to June 2019.)
So, Wing Fung Group Asia has an ROCE of 20%.
Is Wing Fung Group Asia's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Wing Fung Group Asia's ROCE is meaningfully better than the 13% average in the Construction 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, Wing Fung Group Asia's ROCE in absolute terms currently looks quite high.
Wing Fung Group Asia's current ROCE of 20% is lower than its ROCE in the past, which was 42%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Wing Fung Group Asia'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. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. If Wing Fung Group Asia is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Wing Fung Group Asia'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Wing Fung Group Asia has total liabilities of HK$50m and total assets of HK$141m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. A medium level of current liabilities boosts Wing Fung Group Asia's ROCE somewhat.
The Bottom Line On Wing Fung Group Asia's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than Wing Fung Group Asia 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.
I will like Wing Fung Group Asia better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.