Today we'll look at NOVA Group Holdings Limited (HKG:1360) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we 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.
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. 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'.
How Do You Calculate Return On Capital Employed?
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 NOVA Group Holdings:
0.27 = HK$271m ÷ (HK$1.2b - HK$185m) (Based on the trailing twelve months to June 2019.)
So, NOVA Group Holdings has an ROCE of 27%.
Is NOVA Group Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, NOVA Group Holdings's ROCE is meaningfully higher than the 6.8% average in the Media industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, NOVA Group Holdings's ROCE is currently very good.
NOVA Group Holdings has an ROCE of 27%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how NOVA Group 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 NOVA Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How NOVA Group Holdings's Current Liabilities Impact 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.
NOVA Group Holdings has total liabilities of HK$185m and total assets of HK$1.2b. Therefore its current liabilities are equivalent to approximately 16% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
What We Can Learn From NOVA Group Holdings's ROCE
Low current liabilities and high ROCE is a good combination, making NOVA Group Holdings look quite interesting. There might be better investments than NOVA Group Holdings 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.
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.