Today we'll evaluate Chanhigh Holdings Limited (HKG:2017) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Chanhigh Holdings:
0.055 = CN¥47m ÷ (CN¥1.9b - CN¥1.1b) (Based on the trailing twelve months to June 2019.)
So, Chanhigh Holdings has an ROCE of 5.5%.
Is Chanhigh Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Chanhigh Holdings's ROCE appears to be significantly below the 12% average in the Construction industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Chanhigh 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.
We can see that, Chanhigh Holdings currently has an ROCE of 5.5%, less than the 47% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Chanhigh Holdings's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. If Chanhigh Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Chanhigh Holdings's Current Liabilities Skew Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Chanhigh Holdings has total liabilities of CN¥1.1b and total assets of CN¥1.9b. As a result, its current liabilities are equal to approximately 55% of its total assets. Chanhigh Holdings has a fairly high level of current liabilities, meaningfully impacting its ROCE.
What We Can Learn From Chanhigh Holdings's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Chanhigh 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.
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