Today we'll look at DYNAM JAPAN HOLDINGS Co., Ltd. (HKG:6889) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, 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.
Return On Capital Employed (ROCE): What is it?
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. 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'.
So, How Do We Calculate ROCE?
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 DYNAM JAPAN HOLDINGS:
0.13 = JP¥19b ÷ (JP¥185b - JP¥36b) (Based on the trailing twelve months to March 2019.)
Therefore, DYNAM JAPAN HOLDINGS has an ROCE of 13%.
Does DYNAM JAPAN HOLDINGS Have A Good ROCE?
One way to assess ROCE is to compare similar companies. DYNAM JAPAN HOLDINGS's ROCE appears to be substantially greater than the 5.8% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how DYNAM JAPAN HOLDINGS compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how DYNAM JAPAN HOLDINGS's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for DYNAM JAPAN HOLDINGS.
What Are Current Liabilities, And How Do They Affect DYNAM JAPAN 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
DYNAM JAPAN HOLDINGS has total liabilities of JP¥36b and total assets of JP¥185b. Therefore its current liabilities are equivalent to approximately 20% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From DYNAM JAPAN HOLDINGS's ROCE
With that in mind, DYNAM JAPAN HOLDINGS's ROCE appears pretty good. There might be better investments than DYNAM JAPAN 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.