U.S. markets closed

Here’s why Glory Mark Hi-Tech (Holdings) Limited’s (HKG:8159) Returns On Capital Matters So Much

Simply Wall St

Today we are going to look at Glory Mark Hi-Tech (Holdings) Limited (HKG:8159) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?

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 Glory Mark Hi-Tech (Holdings):

0.072 = HK$8.9m ÷ (HK$272m - HK$148m) (Based on the trailing twelve months to September 2019.)

Therefore, Glory Mark Hi-Tech (Holdings) has an ROCE of 7.2%.

Check out our latest analysis for Glory Mark Hi-Tech (Holdings)

Is Glory Mark Hi-Tech (Holdings)'s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Glory Mark Hi-Tech (Holdings)'s ROCE is meaningfully below the Electronic industry average of 9.9%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Glory Mark Hi-Tech (Holdings) stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

Glory Mark Hi-Tech (Holdings) has an ROCE of 7.2%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can see in the image below how Glory Mark Hi-Tech (Holdings)'s ROCE compares to its industry. Click to see more on past growth.

SEHK:8159 Past Revenue and Net Income, January 21st 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. You can check if Glory Mark Hi-Tech (Holdings) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Glory Mark Hi-Tech (Holdings)'s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Glory Mark Hi-Tech (Holdings) has total assets of HK$272m and current liabilities of HK$148m. As a result, its current liabilities are equal to approximately 54% of its total assets. Glory Mark Hi-Tech (Holdings) has a fairly high level of current liabilities, meaningfully impacting its ROCE.

The Bottom Line On Glory Mark Hi-Tech (Holdings)'s ROCE

Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. You might be able to find a better investment than Glory Mark Hi-Tech (Holdings). If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.