Today we'll look at NagaCorp Ltd. (HKG:3918) 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.
Firstly, 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 NagaCorp:
0.25 = US$505m ÷ (US$2.2b - US$152m) (Based on the trailing twelve months to June 2019.)
So, NagaCorp has an ROCE of 25%.
Does NagaCorp Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that NagaCorp's ROCE is meaningfully better than the 6.0% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, NagaCorp's ROCE in absolute terms currently looks quite high.
The image below shows how NagaCorp's ROCE compares to its industry, and you can click it to see more detail on its 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for NagaCorp.
What Are Current Liabilities, And How Do They Affect NagaCorp's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
NagaCorp has total liabilities of US$152m and total assets of US$2.2b. Therefore its current liabilities are equivalent to approximately 6.9% of its total assets. Modest current liabilities are not boosting NagaCorp's very nice ROCE.
The Bottom Line On NagaCorp's ROCE
This is an attractive combination and suggests the company could have potential. There might be better investments than NagaCorp out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.