Today we are going to look at Four Seas Mercantile Holdings Limited (HKG:374) to see whether it might be an attractive investment prospect. 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. 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. Overall, it is a valuable metric that has its flaws. 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 Four Seas Mercantile Holdings:
0.036 = HK$66m ÷ (HK$3.0b - HK$1.1b) (Based on the trailing twelve months to September 2019.)
So, Four Seas Mercantile Holdings has an ROCE of 3.6%.
Does Four Seas Mercantile Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Four Seas Mercantile Holdings's ROCE appears to be significantly below the 10% average in the Food industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Four Seas Mercantile Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Four Seas Mercantile Holdings delivered an ROCE of 3.6%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Four Seas Mercantile Holdings's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. If Four Seas Mercantile Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Four Seas Mercantile Holdings's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Four Seas Mercantile Holdings has total assets of HK$3.0b and current liabilities of HK$1.1b. As a result, its current liabilities are equal to approximately 38% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Four Seas Mercantile Holdings's ROCE is concerning.
The Bottom Line On Four Seas Mercantile Holdings's ROCE
So researching other companies may be a better use of your time. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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