Today we'll look at HJ Capital (International) Holdings Company Limited (HKG:982) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 HJ Capital (International) Holdings:
0.13 = HK$29m ÷ (HK$441m - HK$220m) (Based on the trailing twelve months to June 2019.)
So, HJ Capital (International) Holdings has an ROCE of 13%.
Does HJ Capital (International) Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, HJ Capital (International) Holdings's ROCE is meaningfully higher than the 10.0% average in the Commercial Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how HJ Capital (International) Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how HJ Capital (International) Holdings's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. You can check if HJ Capital (International) Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How HJ Capital (International) Holdings's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
HJ Capital (International) Holdings has total liabilities of HK$220m and total assets of HK$441m. Therefore its current liabilities are equivalent to approximately 50% of its total assets. HJ Capital (International) Holdings has a medium level of current liabilities, which would boost the ROCE.
Our Take On HJ Capital (International) Holdings's ROCE
HJ Capital (International) Holdings's ROCE does look good, but the level of current liabilities also contribute to that. HJ Capital (International) Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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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