U.S. Markets open in 34 mins

Why You Should Care About Orange Sky Golden Harvest Entertainment (Holdings) Limited’s (HKG:1132) Low Return On Capital

Simply Wall St

Today we'll look at Orange Sky Golden Harvest Entertainment (Holdings) Limited (HKG:1132) 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.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?

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 Orange Sky Golden Harvest Entertainment (Holdings):

0.015 = HK$61m ÷ (HK$4.9b - HK$702m) (Based on the trailing twelve months to June 2019.)

Therefore, Orange Sky Golden Harvest Entertainment (Holdings) has an ROCE of 1.5%.

Check out our latest analysis for Orange Sky Golden Harvest Entertainment (Holdings)

Is Orange Sky Golden Harvest Entertainment (Holdings)'s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Orange Sky Golden Harvest Entertainment (Holdings)'s ROCE appears to be significantly below the 14% average in the Entertainment industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Orange Sky Golden Harvest Entertainment (Holdings)'s performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

Orange Sky Golden Harvest Entertainment (Holdings) delivered an ROCE of 1.5%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. The image below shows how Orange Sky Golden Harvest Entertainment (Holdings)'s ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:1132 Past Revenue and Net Income, January 8th 2020

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Orange Sky Golden Harvest Entertainment (Holdings) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Orange Sky Golden Harvest Entertainment (Holdings)'s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.

Orange Sky Golden Harvest Entertainment (Holdings) has total assets of HK$4.9b and current liabilities of HK$702m. As a result, its current liabilities are equal to approximately 14% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

Our Take On Orange Sky Golden Harvest Entertainment (Holdings)'s ROCE

Orange Sky Golden Harvest Entertainment (Holdings) has a poor ROCE, and there may be better investment prospects out there. 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).

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.

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. Thank you for reading.