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Should You Like KNT Holdings Limited’s (HKG:1025) High Return On Capital Employed?

Simply Wall St

Today we'll evaluate KNT Holdings Limited (HKG:1025) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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'.

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 KNT Holdings:

0.33 = HK$42m ÷ (HK$171m - HK$42m) (Based on the trailing twelve months to March 2019.)

So, KNT Holdings has an ROCE of 33%.

Check out our latest analysis for KNT Holdings

Does KNT Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. KNT Holdings's ROCE appears to be substantially greater than the 9.5% average in the Luxury industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, KNT Holdings's ROCE currently appears to be excellent.

KNT Holdings's current ROCE of 33% is lower than 3 years ago, when the company reported a 62% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how KNT Holdings's ROCE compares to its industry. Click to see more on past growth.

SEHK:1025 Past Revenue and Net Income, September 23rd 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If KNT Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

KNT Holdings's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

KNT Holdings has total assets of HK$171m and current liabilities of HK$42m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

What We Can Learn From KNT Holdings's ROCE

Low current liabilities and high ROCE is a good combination, making KNT Holdings look quite interesting. KNT 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 KNT 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.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.