Today we'll look at Honworld Group Limited (HKG:2226) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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'.
So, How Do We Calculate ROCE?
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 Honworld Group:
0.12 = CN¥293m ÷ (CN¥3.9b - CN¥1.4b) (Based on the trailing twelve months to June 2019.)
So, Honworld Group has an ROCE of 12%.
Does Honworld Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Honworld Group's ROCE is fairly close to the Food industry average of 10%. Independently of how Honworld Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Honworld Group's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is Honworld Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Honworld Group'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 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.
Honworld Group has total assets of CN¥3.9b and current liabilities of CN¥1.4b. As a result, its current liabilities are equal to approximately 36% of its total assets. With this level of current liabilities, Honworld Group's ROCE is boosted somewhat.
The Bottom Line On Honworld Group's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Honworld Group 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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