Today we'll look at Grand Ming Group Holdings Limited (HKG:1271) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Grand Ming Group Holdings:
0.029 = HK$178m ÷ (HK$7.2b - HK$1.2b) (Based on the trailing twelve months to September 2019.)
So, Grand Ming Group Holdings has an ROCE of 2.9%.
Is Grand Ming Group Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Grand Ming Group Holdings's ROCE is meaningfully below the Construction industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Grand Ming Group Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. There are potentially more appealing investments elsewhere.
Grand Ming Group Holdings's current ROCE of 2.9% is lower than its ROCE in the past, which was 5.0%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Grand Ming Group Holdings's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Grand Ming Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Grand Ming Group Holdings's Current Liabilities Skew 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.
Grand Ming Group Holdings has current liabilities of HK$1.2b and total assets of HK$7.2b. As a result, its current liabilities are equal to approximately 16% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Grand Ming Group Holdings's ROCE
Grand Ming Group Holdings has a poor ROCE, and there may be better investment prospects out there. 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 firstname.lastname@example.org. 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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