Today we'll evaluate L.K. Technology Holdings Limited (HKG:558) to determine whether it could have potential as an investment idea. 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.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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?
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 L.K. Technology Holdings:
0.068 = HK$160m ÷ (HK$4.8b - HK$2.5b) (Based on the trailing twelve months to September 2019.)
Therefore, L.K. Technology Holdings has an ROCE of 6.8%.
Does L.K. Technology Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see L.K. Technology Holdings's ROCE is meaningfully below the Machinery industry average of 11%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, L.K. Technology Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
The image below shows how L.K. Technology Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. How cyclical is L.K. Technology Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
L.K. Technology Holdings's Current Liabilities And Their Impact On 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.
L.K. Technology Holdings has total liabilities of HK$2.5b and total assets of HK$4.8b. As a result, its current liabilities are equal to approximately 51% of its total assets. With a high level of current liabilities, L.K. Technology Holdings will experience a boost to its ROCE.
The Bottom Line On L.K. Technology Holdings's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. 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.
I will like L.K. Technology Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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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