Today we are going to look at TCL Electronics Holdings Limited (HKG:1070) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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?
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 TCL Electronics Holdings:
0.10 = HK$1.2b ÷ (HK$28b - HK$17b) (Based on the trailing twelve months to June 2019.)
Therefore, TCL Electronics Holdings has an ROCE of 10%.
Does TCL Electronics Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that TCL Electronics Holdings's ROCE is fairly close to the Consumer Durables industry average of 10%. Regardless of where TCL Electronics Holdings 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 , TCL Electronics Holdings currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 3.4%. This makes us think the business might be improving. The image below shows how TCL Electronics Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for TCL Electronics Holdings.
What Are Current Liabilities, And How Do They Affect TCL Electronics Holdings's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
TCL Electronics Holdings has total assets of HK$28b and current liabilities of HK$17b. As a result, its current liabilities are equal to approximately 60% of its total assets. TCL Electronics Holdings's current liabilities are fairly high, which increases its ROCE significantly.
The Bottom Line On TCL Electronics Holdings's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. TCL Electronics 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.
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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.