Today we'll evaluate KML Technology Group Limited (HKG:8065) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 KML Technology Group:
0.12 = HK$19m ÷ (HK$206m - HK$54m) (Based on the trailing twelve months to September 2019.)
Therefore, KML Technology Group has an ROCE of 12%.
Is KML Technology Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that KML Technology Group's ROCE is fairly close to the Construction industry average of 12%. Independently of how KML Technology Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, KML Technology Group currently has an ROCE of 12%, less than the 22% it reported 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how KML Technology Group's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is KML Technology Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How KML Technology Group's Current Liabilities Impact 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.
KML Technology Group has total assets of HK$206m and current liabilities of HK$54m. As a result, its current liabilities are equal to approximately 26% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From KML Technology Group's ROCE
This is good to see, and with a sound ROCE, KML Technology Group could be worth a closer look. KML Technology Group 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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