Today we'll evaluate EGL Holdings Company Limited (HKG:6882) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. 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. 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 EGL Holdings:
0.03 = HK$20m ÷ (HK$1.1b - HK$418m) (Based on the trailing twelve months to June 2019.)
Therefore, EGL Holdings has an ROCE of 3.0%.
Does EGL Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, EGL Holdings's ROCE appears meaningfully below the 5.1% average reported by the Hospitality industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how EGL Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. It is likely that there are more attractive prospects out there.
EGL Holdings's current ROCE of 3.0% is lower than 3 years ago, when the company reported a 25% ROCE. So investors might consider if it has had issues recently. You can see in the image below how EGL 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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. You can check if EGL Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
EGL Holdings's Current Liabilities And Their Impact On 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
EGL Holdings has total assets of HK$1.1b and current liabilities of HK$418m. As a result, its current liabilities are equal to approximately 39% of its total assets. With a medium level of current liabilities boosting the ROCE a little, EGL Holdings's low ROCE is unappealing.
Our Take On EGL Holdings's ROCE
So researching other companies may be a better use of your time. 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.
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