Today we'll look at Vipshop Holdings Limited (NYSE:VIPS) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we 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.
What is 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Vipshop Holdings:
0.17 = CN¥3.9b ÷ (CN¥42b - CN¥19b) (Based on the trailing twelve months to September 2019.)
So, Vipshop Holdings has an ROCE of 17%.
Does Vipshop Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Vipshop Holdings's ROCE appears to be substantially greater than the 7.7% average in the Online Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Vipshop Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Vipshop Holdings's current ROCE of 17% is lower than 3 years ago, when the company reported a 26% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Vipshop Holdings'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Vipshop Holdings's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Vipshop Holdings has total assets of CN¥42b and current liabilities of CN¥19b. As a result, its current liabilities are equal to approximately 46% of its total assets. With this level of current liabilities, Vipshop Holdings's ROCE is boosted somewhat.
The Bottom Line On Vipshop Holdings's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Vipshop Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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