Today we'll look at Jimu Group Limited (HKG:8187) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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 Jimu Group:
0.20 = HK$11m ÷ (HK$105m - HK$48m) (Based on the trailing twelve months to September 2019.)
Therefore, Jimu Group has an ROCE of 20%.
Does Jimu Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Jimu Group's ROCE appears to be substantially greater than the 9.6% average in the Luxury industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Jimu Group's ROCE currently appears to be excellent.
You can click on the image below to see (in greater detail) how Jimu Group'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, after all, simply a snap shot of a single year. How cyclical is Jimu Group? 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 Jimu Group'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Jimu Group has total liabilities of HK$48m and total assets of HK$105m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Jimu Group's ROCE is boosted somewhat by its middling amount of current liabilities.
What We Can Learn From Jimu Group's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than Jimu Group 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 Jimu Group 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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