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Today we are going to look at CMON Limited (HKG:8278) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 CMON:
0.15 = US$4.0m ÷ (US$38m - US$11m) (Based on the trailing twelve months to March 2019.)
Therefore, CMON has an ROCE of 15%.
Does CMON Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, CMON's ROCE is meaningfully higher than the 12% average in the Leisure industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where CMON sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
CMON's current ROCE of 15% is lower than its ROCE in the past, which was 28%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how CMON'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is CMON? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How CMON's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
CMON has total assets of US$38m and current liabilities of US$11m. Therefore its current liabilities are equivalent to approximately 29% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On CMON's ROCE
This is good to see, and with a sound ROCE, CMON could be worth a closer look. CMON looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.