Today we'll look at IBI Group Holdings Limited (HKG:1547) and reflect on its potential as an investment. 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 IBI Group Holdings:
0.14 = HK$19m ÷ (HK$367m - HK$232m) (Based on the trailing twelve months to September 2018.)
Therefore, IBI Group Holdings has an ROCE of 14%.
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Is IBI Group Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that IBI Group Holdings's ROCE is fairly close to the Construction industry average of 14%. Independently of how IBI Group Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
IBI Group Holdings's current ROCE of 14% is lower than its ROCE in the past, which was 59%, 3 years ago. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. You can check if IBI Group Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How IBI Group Holdings'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.
IBI Group Holdings has total assets of HK$367m and current liabilities of HK$232m. Therefore its current liabilities are equivalent to approximately 63% of its total assets. IBI Group Holdings has a relatively high level of current liabilities, boosting its ROCE meaningfully.
What We Can Learn From IBI Group Holdings's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. There might be better investments than IBI Group 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.
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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. Thank you for reading.