Today we'll look at Telecom Digital Holdings Limited (HKG:6033) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Telecom Digital Holdings:
0.41 = HK$145m ÷ (HK$659m - HK$305m) (Based on the trailing twelve months to March 2019.)
Therefore, Telecom Digital Holdings has an ROCE of 41%.
Does Telecom Digital Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Telecom Digital Holdings's ROCE is meaningfully higher than the 10% average in the Electronic industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Telecom Digital Holdings's ROCE currently appears to be excellent.
In our analysis, Telecom Digital Holdings's ROCE appears to be 41%, compared to 3 years ago, when its ROCE was 29%. This makes us think the business might be improving. You can see in the image below how Telecom Digital Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. You can check if Telecom Digital Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Telecom Digital Holdings's Current Liabilities Skew 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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Telecom Digital Holdings has total assets of HK$659m and current liabilities of HK$305m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. A medium level of current liabilities boosts Telecom Digital Holdings's ROCE somewhat.
Our Take On Telecom Digital Holdings's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Telecom Digital 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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. Thank you for reading.