Today we'll look at REM Group (Holdings) Limited (HKG:1750) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 REM Group (Holdings):
0.10 = HK$20m ÷ (HK$253m - HK$55m) (Based on the trailing twelve months to December 2018.)
So, REM Group (Holdings) has an ROCE of 10%.
Is REM Group (Holdings)'s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, REM Group (Holdings)'s ROCE appears to be around the 10% average of the Electrical industry. Independently of how REM Group (Holdings) compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , REM Group (Holdings) currently has an ROCE of 10%, less than the 49% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how REM Group (Holdings)'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 REM Group (Holdings)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect REM Group (Holdings)'s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
REM Group (Holdings) has total liabilities of HK$55m and total assets of HK$253m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On REM Group (Holdings)'s ROCE
This is good to see, and with a sound ROCE, REM Group (Holdings) could be worth a closer look. REM Group (Holdings) 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.
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.