Today we are going to look at Sunfonda Group Holdings Limited (HKG:1771) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. 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 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Sunfonda Group Holdings:
0.11 = CN¥237m ÷ (CN¥5.3b - CN¥3.1b) (Based on the trailing twelve months to December 2019.)
Therefore, Sunfonda Group Holdings has an ROCE of 11%.
Does Sunfonda Group Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Sunfonda Group Holdings's ROCE is around the 12% average reported by the Specialty Retail industry. Independently of how Sunfonda Group 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 Sunfonda Group Holdings'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Sunfonda Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Sunfonda Group Holdings's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Sunfonda Group Holdings has current liabilities of CN¥3.1b and total assets of CN¥5.3b. As a result, its current liabilities are equal to approximately 58% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
Our Take On Sunfonda Group Holdings's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. Sunfonda Group 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.
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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