Today we'll look at Luk Hing Entertainment Group Holdings Limited (HKG:8052) and reflect on its potential as an investment. 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. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Luk Hing Entertainment Group Holdings:
0.062 = HK$8.5m ÷ (HK$194m - HK$56m) (Based on the trailing twelve months to June 2019.)
So, Luk Hing Entertainment Group Holdings has an ROCE of 6.2%.
Is Luk Hing Entertainment Group Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Luk Hing Entertainment Group Holdings's ROCE is around the 6.0% average reported by the Hospitality industry. Setting aside the industry comparison for now, Luk Hing Entertainment Group Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Luk Hing Entertainment Group Holdings's current ROCE of 6.2% is lower than its ROCE in the past, which was 24%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Luk Hing Entertainment Group Holdings's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. If Luk Hing Entertainment Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Luk Hing Entertainment Group Holdings's 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Luk Hing Entertainment Group Holdings has total liabilities of HK$56m and total assets of HK$194m. Therefore its current liabilities are equivalent to approximately 29% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On Luk Hing Entertainment Group Holdings's ROCE
That said, Luk Hing Entertainment Group Holdings's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Luk Hing Entertainment Group Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Luk Hing Entertainment Group 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.
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