Today we'll look at Hilong Holding Limited (HKG:1623) and reflect on its potential as an investment. 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. 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 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. 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?
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 Hilong Holding:
0.13 = CN¥541m ÷ (CN¥8.2b - CN¥4.2b) (Based on the trailing twelve months to June 2019.)
Therefore, Hilong Holding has an ROCE of 13%.
Does Hilong Holding Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Hilong Holding's ROCE is fairly close to the Energy Services industry average of 14%. Independently of how Hilong Holding compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Hilong Holding currently has an ROCE of 13%, compared to its ROCE of 5.5% 3 years ago. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Hilong Holding's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. Remember that most companies like Hilong Holding are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hilong Holding.
Hilong Holding's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Hilong Holding has total assets of CN¥8.2b and current liabilities of CN¥4.2b. As a result, its current liabilities are equal to approximately 51% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From Hilong Holding's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. Hilong Holding shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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