Today we'll evaluate Shi Shi Services Limited (HKG:8181) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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 Shi Shi Services:
0.12 = HK$35m ÷ (HK$390m - HK$93m) (Based on the trailing twelve months to December 2019.)
Therefore, Shi Shi Services has an ROCE of 12%.
Does Shi Shi Services Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Shi Shi Services's ROCE is around the 11% average reported by the Consumer Services industry. Independently of how Shi Shi Services compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Shi Shi Services's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. How cyclical is Shi Shi Services? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Shi Shi Services's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Shi Shi Services has current liabilities of HK$93m and total assets of HK$390m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Shi Shi Services's ROCE
With that in mind, Shi Shi Services's ROCE appears pretty good. Shi Shi Services 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.
I will like Shi Shi Services better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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