Today we'll evaluate CK Hutchison Holdings Limited (HKG:1) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 CK Hutchison Holdings:
0.049 = HK$51b ÷ (HK$1.3t - HK$233b) (Based on the trailing twelve months to June 2019.)
Therefore, CK Hutchison Holdings has an ROCE of 4.9%.
Is CK Hutchison Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. CK Hutchison Holdings's ROCE appears to be substantially greater than the 3.3% average in the Industrials industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how CK Hutchison 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.
You can see in the image below how CK Hutchison Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for CK Hutchison Holdings.
How CK Hutchison Holdings's Current Liabilities Impact 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
CK Hutchison Holdings has total liabilities of HK$233b and total assets of HK$1.3t. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On CK Hutchison Holdings's ROCE
With that in mind, we're not overly impressed with CK Hutchison Holdings's ROCE, so it may not be the most appealing prospect. 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).
CK Hutchison Holdings is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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.
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.