Today we are going to look at Tao Heung Holdings Limited (HKG:573) 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.
First up, we'll look at what ROCE is and how we calculate it. 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.
Understanding 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Tao Heung Holdings:
0.084 = HK$150m ÷ (HK$2.4b - HK$598m) (Based on the trailing twelve months to December 2018.)
Therefore, Tao Heung Holdings has an ROCE of 8.4%.
Does Tao Heung Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Tao Heung Holdings's ROCE is meaningfully better than the 5.7% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how Tao Heung Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
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. ROCE is only a point-in-time measure. How cyclical is Tao Heung Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Tao Heung 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Tao Heung Holdings has total liabilities of HK$598m and total assets of HK$2.4b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
Our Take On Tao Heung Holdings's ROCE
If Tao Heung Holdings continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Tao Heung Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Tao Heung 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.
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.