LH Group Limited (HKG:1978) Earns Among The Best Returns In Its Industry
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Today we’ll evaluate LH Group Limited (HKG:1978) 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. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 LH Group:
0.11 = HK$47m ÷ (HK$541m – HK$146m) (Based on the trailing twelve months to June 2018.)
Therefore, LH Group has an ROCE of 11%.
See our latest analysis for LH Group
Is LH Group’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, LH Group’s ROCE is meaningfully higher than the 5.2% 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. Independently of how LH Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. ROCE is, after all, simply a snap shot of a single year. If LH Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
LH Group’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
LH Group has total assets of HK$541m and current liabilities of HK$146m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From LH Group’s ROCE
Overall, LH Group has a decent ROCE and could be worthy of further research. You might be able to find a better buy than LH Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
