Is Mainland Headwear Holdings Limited’s (HKG:1100) 11% Return On Capital Employed Good News?
Today we’ll evaluate Mainland Headwear Holdings Limited (HKG:1100) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE 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?
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 Mainland Headwear Holdings:
0.11 = HK$81m ÷ (HK$990m – HK$290m) (Based on the trailing twelve months to June 2018.)
Therefore, Mainland Headwear Holdings has an ROCE of 11%.
See our latest analysis for Mainland Headwear Holdings
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Does Mainland Headwear Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Mainland Headwear Holdings’s ROCE is fairly close to the Luxury industry average of 9.4%. Independently of how Mainland Headwear Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Mainland Headwear Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Mainland Headwear Holdings’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Mainland Headwear Holdings has total liabilities of HK$290m and total assets of HK$990m. As a result, its current liabilities are equal to approximately 29% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Mainland Headwear Holdings’s ROCE
Overall, Mainland Headwear Holdings has a decent ROCE and could be worthy of further research. But note: Mainland Headwear Holdings may not be the best stock to buy. 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).
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.
