Today we'll evaluate Kingdom Holdings Limited (HKG:528) to determine whether it could have potential as an investment idea. 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. 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Kingdom Holdings:
0.19 = CN¥240m ÷ (CN¥2.4b - CN¥1.1b) (Based on the trailing twelve months to June 2019.)
Therefore, Kingdom Holdings has an ROCE of 19%.
Does Kingdom Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Kingdom Holdings's ROCE is meaningfully higher than the 9.6% average in the Luxury industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Kingdom Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Kingdom Holdings currently has an ROCE of 19% compared to its ROCE 3 years ago, which was 11%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Kingdom Holdings's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. If Kingdom Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Kingdom Holdings'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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Kingdom Holdings has total assets of CN¥2.4b and current liabilities of CN¥1.1b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Kingdom Holdings has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On Kingdom Holdings's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Kingdom 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.
Kingdom Holdings is not the only stock that insiders are buying. 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.