Today we'll evaluate Smart Globe Holdings Limited (HKG:8485) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. 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 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?
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 Smart Globe Holdings:
0.25 = HK$26m ÷ (HK$136m - HK$32m) (Based on the trailing twelve months to June 2019.)
So, Smart Globe Holdings has an ROCE of 25%.
Does Smart Globe Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Smart Globe Holdings's ROCE is meaningfully higher than the 9.9% average in the Commercial Services 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 the industry comparison, in absolute terms, Smart Globe Holdings's ROCE currently appears to be excellent.
Smart Globe Holdings's current ROCE of 25% is lower than 3 years ago, when the company reported a 42% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Smart Globe Holdings's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Smart Globe Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Smart Globe 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Smart Globe Holdings has total assets of HK$136m and current liabilities of HK$32m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From Smart Globe Holdings's ROCE
With low current liabilities and a high ROCE, Smart Globe Holdings could be worthy of further investigation. Smart Globe 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.