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Why You Should Care About Grand Ming Group Holdings Limited’s (HKG:1271) Low Return On Capital

Simply Wall St

Today we are going to look at Grand Ming Group Holdings Limited (HKG:1271) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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'.

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 Grand Ming Group Holdings:

0.035 = HK$212m ÷ (HK$7.1b - HK$978m) (Based on the trailing twelve months to March 2019.)

So, Grand Ming Group Holdings has an ROCE of 3.5%.

View our latest analysis for Grand Ming Group Holdings

Does Grand Ming Group Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Grand Ming Group Holdings's ROCE appears meaningfully below the 13% average reported by the Construction industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Grand Ming Group Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.

Grand Ming Group Holdings's current ROCE of 3.5% is lower than 3 years ago, when the company reported a 4.7% ROCE. So investors might consider if it has had issues recently. The image below shows how Grand Ming Group Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:1271 Past Revenue and Net Income, August 14th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Grand Ming Group Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Grand Ming Group Holdings's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Grand Ming Group Holdings has total liabilities of HK$978m and total assets of HK$7.1b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Grand Ming Group Holdings's ROCE

While that is good to see, Grand Ming Group Holdings has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.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.