Today we are going to look at International Housewares Retail Company Limited (HKG:1373) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 International Housewares Retail:
0.17 = HK$145m ÷ (HK$1.5b - HK$633m) (Based on the trailing twelve months to October 2019.)
So, International Housewares Retail has an ROCE of 17%.
Is International Housewares Retail's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that International Housewares Retail's ROCE is meaningfully better than the 12% average in the Specialty Retail 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. Separate from International Housewares Retail's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how International Housewares Retail'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 only a point-in-time measure. How cyclical is International Housewares Retail? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect International Housewares Retail's 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 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.
International Housewares Retail has total liabilities of HK$633m and total assets of HK$1.5b. Therefore its current liabilities are equivalent to approximately 42% of its total assets. With this level of current liabilities, International Housewares Retail's ROCE is boosted somewhat.
What We Can Learn From International Housewares Retail's ROCE
International Housewares Retail's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than International Housewares Retail 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.
I will like International Housewares Retail better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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