Today we'll evaluate PPS International (Holdings) Limited (HKG:8201) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 PPS International (Holdings):
0.098 = HK$22m ÷ (HK$280m - HK$54m) (Based on the trailing twelve months to September 2019.)
So, PPS International (Holdings) has an ROCE of 9.8%.
Does PPS International (Holdings) Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see PPS International (Holdings)'s ROCE is around the 10% average reported by the Commercial Services industry. Aside from the industry comparison, PPS International (Holdings)'s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
PPS International (Holdings) delivered an ROCE of 9.8%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can see in the image below how PPS International (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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is PPS International (Holdings)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How PPS International (Holdings)'s Current Liabilities Impact 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
PPS International (Holdings) has total assets of HK$280m and current liabilities of HK$54m. As a result, its current liabilities are equal to approximately 19% 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 PPS International (Holdings)'s ROCE
With that in mind, we're not overly impressed with PPS International (Holdings)'s ROCE, so it may not be the most appealing prospect. 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).
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 email@example.com. 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.