Today we are going to look at Milestone Builder Holdings Limited (HKG:1667) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Milestone Builder Holdings:
0.15 = HK$22m ÷ (HK$459m - HK$307m) (Based on the trailing twelve months to March 2019.)
Therefore, Milestone Builder Holdings has an ROCE of 15%.
Is Milestone Builder Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Milestone Builder Holdings's ROCE is meaningfully higher than the 12% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Milestone Builder Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Milestone Builder Holdings's current ROCE of 15% is lower than 3 years ago, when the company reported a 57% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Milestone Builder Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Milestone Builder Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Milestone Builder Holdings'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.
Milestone Builder Holdings has total assets of HK$459m and current liabilities of HK$307m. As a result, its current liabilities are equal to approximately 67% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
Our Take On Milestone Builder Holdings's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. Milestone Builder 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.