Today we'll evaluate IPE Group Limited (HKG:929) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. In brief, it is a useful tool, but it is not without drawbacks. 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'.
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 IPE Group:
0.043 = HK$80m ÷ (HK$2.1b - HK$232m) (Based on the trailing twelve months to June 2019.)
Therefore, IPE Group has an ROCE of 4.3%.
Does IPE Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, IPE Group's ROCE appears meaningfully below the 11% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how IPE Group stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
We can see that, IPE Group currently has an ROCE of 4.3%, less than the 6.1% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how IPE Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. If IPE Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do IPE Group'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.
IPE Group has total liabilities of HK$232m and total assets of HK$2.1b. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
The Bottom Line On IPE Group's ROCE
IPE Group has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than IPE 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 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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