Today we'll evaluate Karrie International Holdings Limited (HKG:1050) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
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. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Karrie International Holdings:
0.22 = HK$383m ÷ (HK$2.7b - HK$947m) (Based on the trailing twelve months to September 2019.)
Therefore, Karrie International Holdings has an ROCE of 22%.
Is Karrie International Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Karrie International Holdings's ROCE is meaningfully higher than the 9.9% average in the Electronic industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Karrie International Holdings's ROCE is currently very good.
In our analysis, Karrie International Holdings's ROCE appears to be 22%, compared to 3 years ago, when its ROCE was 16%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Karrie International Holdings's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. You can check if Karrie International Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Karrie International Holdings's Current Liabilities Skew Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Karrie International Holdings has total liabilities of HK$947m and total assets of HK$2.7b. As a result, its current liabilities are equal to approximately 35% of its total assets. Karrie International Holdings's ROCE is boosted somewhat by its middling amount of current liabilities.
Our Take On Karrie International Holdings's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Karrie International 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.
I will like Karrie International Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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