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Today we are going to look at Pacific Textiles Holdings Limited (HKG:1382) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 Pacific Textiles Holdings:
0.28 = HK$957m ÷ (HK$4.5b - HK$1.1b) (Based on the trailing twelve months to March 2019.)
So, Pacific Textiles Holdings has an ROCE of 28%.
Does Pacific Textiles Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Pacific Textiles Holdings's ROCE is meaningfully better than the 11% average in the Luxury 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, Pacific Textiles Holdings's ROCE is currently very good.
The image below shows how Pacific Textiles Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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 Pacific Textiles Holdings.
Do Pacific Textiles 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Pacific Textiles Holdings has total assets of HK$4.5b and current liabilities of HK$1.1b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Pacific Textiles Holdings's ROCE
Low current liabilities and high ROCE is a good combination, making Pacific Textiles Holdings look quite interesting. Pacific Textiles Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.