Today we'll look at Man Wah Holdings Limited (HKG:1999) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the 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. 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 Man Wah Holdings:
0.17 = HK$1.5b ÷ (HK$13b - HK$4.6b) (Based on the trailing twelve months to March 2019.)
Therefore, Man Wah Holdings has an ROCE of 17%.
Is Man Wah Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. Man Wah Holdings's ROCE appears to be substantially greater than the 10% average in the Consumer Durables 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. Separate from Man Wah Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Man Wah Holdings currently has an ROCE of 17%, less than the 28% it reported 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Man Wah Holdings's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Man Wah Holdings.
Do Man Wah Holdings'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Man Wah Holdings has total liabilities of HK$4.6b and total assets of HK$13b. As a result, its current liabilities are equal to approximately 35% of its total assets. With this level of current liabilities, Man Wah Holdings's ROCE is boosted somewhat.
The Bottom Line On Man Wah Holdings's ROCE
Man Wah Holdings's ROCE does look good, but the level of current liabilities also contribute to that. Man Wah Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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.