Today we'll look at Goodbaby International Holdings Limited (HKG:1086) 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. Then we'll compare its ROCE 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 Goodbaby International Holdings:
0.032 = HK$257m ÷ (HK$11b - HK$3.0b) (Based on the trailing twelve months to June 2019.)
Therefore, Goodbaby International Holdings has an ROCE of 3.2%.
Is Goodbaby International Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Goodbaby International Holdings's ROCE appears meaningfully below the 8.6% average reported by the Leisure industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Goodbaby International Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.
Goodbaby International Holdings's current ROCE of 3.2% is lower than its ROCE in the past, which was 7.4%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Goodbaby International Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Goodbaby International Holdings.
Goodbaby International Holdings'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. 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.
Goodbaby International Holdings has total assets of HK$11b and current liabilities of HK$3.0b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Goodbaby International Holdings's ROCE
Goodbaby International Holdings has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
There are plenty of other companies that have insiders buying up shares. You probably do 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.