Today we'll evaluate Glory Sun Financial Group Limited (HKG:1282) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?
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 Glory Sun Financial Group:
0.082 = HK$1.3b ÷ (HK$29b - HK$14b) (Based on the trailing twelve months to December 2019.)
Therefore, Glory Sun Financial Group has an ROCE of 8.2%.
Does Glory Sun Financial Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Glory Sun Financial Group's ROCE is around the 7.8% average reported by the Tech industry. Separate from how Glory Sun Financial Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
We can see that, Glory Sun Financial Group currently has an ROCE of 8.2% compared to its ROCE 3 years ago, which was 5.8%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Glory Sun Financial Group'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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Glory Sun Financial Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Glory Sun Financial Group's Current Liabilities And Their Impact On Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Glory Sun Financial Group has current liabilities of HK$14b and total assets of HK$29b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Glory Sun Financial Group's ROCE is improved somewhat by its moderate amount of current liabilities.
The Bottom Line On Glory Sun Financial Group's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better investment than Glory Sun Financial Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 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.
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. Thank you for reading.