Today we'll look at Lion Rock Group Limited (HKG:1127) 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. 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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'.
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 Lion Rock Group:
0.12 = HK$143m ÷ (HK$1.8b - HK$577m) (Based on the trailing twelve months to June 2019.)
So, Lion Rock Group has an ROCE of 12%.
Does Lion Rock Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Lion Rock Group's ROCE appears to be around the 10% average of the Commercial Services industry. Regardless of where Lion Rock Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Lion Rock Group currently has an ROCE of 12%, less than the 20% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Lion Rock Group'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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Lion Rock Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Lion Rock Group's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Lion Rock Group has total liabilities of HK$577m and total assets of HK$1.8b. As a result, its current liabilities are equal to approximately 32% of its total assets. Lion Rock Group has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On Lion Rock Group's ROCE
Lion Rock Group's ROCE does look good, but the level of current liabilities also contribute to that. Lion Rock Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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.