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Are S.A.I Leisure Group Company Limited’s (HKG:1832) High Returns Really That Great?

Simply Wall St

Today we'll look at S.A.I Leisure Group Company Limited (HKG:1832) 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, 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.

Understanding 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. 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 S.A.I Leisure Group:

0.095 = US$11m ÷ (US$126m - US$10m) (Based on the trailing twelve months to June 2019.)

So, S.A.I Leisure Group has an ROCE of 9.5%.

Check out our latest analysis for S.A.I Leisure Group

Does S.A.I Leisure Group Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, S.A.I Leisure Group's ROCE is meaningfully higher than the 5.1% average in the Hospitality 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. Setting aside the industry comparison for now, S.A.I Leisure Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

We can see that, S.A.I Leisure Group currently has an ROCE of 9.5%, less than the 26% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how S.A.I Leisure Group's past growth compares to other companies.

SEHK:1832 Past Revenue and Net Income, November 13th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is S.A.I Leisure Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do S.A.I Leisure Group'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

S.A.I Leisure Group has total liabilities of US$10m and total assets of US$126m. As a result, its current liabilities are equal to approximately 8.3% of its total assets. S.A.I Leisure Group reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On S.A.I Leisure Group's ROCE

Based on this information, S.A.I Leisure Group appears to be a mediocre business. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.