Today we'll look at ST International Holdings Company Limited (HKG:8521) and reflect on its potential as an investment. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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'.
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 ST International Holdings:
0.17 = HK$26m ÷ (HK$211m - HK$59m) (Based on the trailing twelve months to June 2019.)
So, ST International Holdings has an ROCE of 17%.
Is ST International Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, ST International Holdings's ROCE is meaningfully higher than the 9.5% average in the Luxury industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from ST International Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
ST International Holdings's current ROCE of 17% is lower than 3 years ago, when the company reported a 68% ROCE. So investors might consider if it has had issues recently. You can see in the image below how ST International Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. If ST International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How ST International Holdings's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
ST International Holdings has total liabilities of HK$59m and total assets of HK$211m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From ST International Holdings's ROCE
This is good to see, and with a sound ROCE, ST International Holdings could be worth a closer look. ST International Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like ST International 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.
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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.