Today we'll look at Hutchison Telecommunications Hong Kong Holdings Limited (HKG:215) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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. 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 Hutchison Telecommunications Hong Kong Holdings:
0.023 = HK$282m ÷ (HK$14b - HK$2.0b) (Based on the trailing twelve months to June 2019.)
So, Hutchison Telecommunications Hong Kong Holdings has an ROCE of 2.3%.
Does Hutchison Telecommunications Hong Kong Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Hutchison Telecommunications Hong Kong Holdings's ROCE appears meaningfully below the 11% average reported by the Wireless Telecom industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Hutchison Telecommunications Hong Kong Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Hutchison Telecommunications Hong Kong Holdings's current ROCE of 2.3% is lower than 3 years ago, when the company reported a 6.9% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Hutchison Telecommunications Hong Kong Holdings's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. 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 Hutchison Telecommunications Hong Kong Holdings.
Do Hutchison Telecommunications Hong Kong Holdings's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Hutchison Telecommunications Hong Kong Holdings has current liabilities of HK$2.0b and total assets of HK$14b. As a result, its current liabilities are equal to approximately 14% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Hutchison Telecommunications Hong Kong Holdings's ROCE
Hutchison Telecommunications Hong Kong Holdings has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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