Today we'll look at Magnificent Hotel Investments Limited (HKG:201) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its 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. 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 Magnificent Hotel Investments:
0.044 = HK$196m ÷ (HK$4.6b - HK$195m) (Based on the trailing twelve months to June 2019.)
So, Magnificent Hotel Investments has an ROCE of 4.4%.
Is Magnificent Hotel Investments's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Magnificent Hotel Investments's ROCE appears to be around the 5.0% average of the Hospitality industry. Regardless of how Magnificent Hotel Investments stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
We can see that, Magnificent Hotel Investments currently has an ROCE of 4.4% compared to its ROCE 3 years ago, which was 2.5%. This makes us wonder if the company is improving. You can see in the image below how Magnificent Hotel Investments'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, after all, simply a snap shot of a single year. If Magnificent Hotel Investments is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Magnificent Hotel Investments's Current Liabilities And Their Impact On 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.
Magnificent Hotel Investments has total assets of HK$4.6b and current liabilities of HK$195m. Therefore its current liabilities are equivalent to approximately 4.2% of its total assets. With barely any current liabilities, there is minimal impact on Magnificent Hotel Investments's admittedly low ROCE.
What We Can Learn From Magnificent Hotel Investments's ROCE
Nevertheless, there are potentially more attractive companies to invest in. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 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. Thank you for reading.