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Today we are going to look at REM Group (Holdings) Limited (HKG:1750) 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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’.
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 REM Group (Holdings):
0.13 = HK$29m ÷ (HK$240m – HK$45m) (Based on the trailing twelve months to June 2018.)
Therefore, REM Group (Holdings) has an ROCE of 13%.
Is REM Group (Holdings)’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. REM Group (Holdings)’s ROCE appears to be substantially greater than the 8.2% average in the Electrical industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where REM Group (Holdings) sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
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, after all, simply a snap shot of a single year. If REM Group (Holdings) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do REM Group (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. 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.
REM Group (Holdings) has total assets of HK$240m and current liabilities of HK$45m. As a result, its current liabilities are equal to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On REM Group (Holdings)’s ROCE
With that in mind, REM Group (Holdings)’s ROCE appears pretty good. Of course you might be able to find a better stock than REM Group (Holdings). So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.