Why Hock Lian Seng Holdings Limited’s (SGX:J2T) Return On Capital Employed Looks Uninspiring
Today we’ll look at Hock Lian Seng Holdings Limited (SGX:J2T) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.’
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 Hock Lian Seng Holdings:
0.13 = S$21m ÷ (S$340m – S$140m) (Based on the trailing twelve months to September 2018.)
Therefore, Hock Lian Seng Holdings has an ROCE of 13%.
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Is Hock Lian Seng Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Hock Lian Seng Holdings’s ROCE is meaningfully better than the 6.9% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Hock Lian Seng Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Hock Lian Seng Holdings’s current ROCE of 13% is lower than 3 years ago, when the company reported a 44% ROCE. So investors might consider if it has had issues recently.
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, after all, simply a snap shot of a single year. You can check if Hock Lian Seng Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Hock Lian Seng 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. 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.
Hock Lian Seng Holdings has total assets of S$340m and current liabilities of S$140m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. Hock Lian Seng Holdings has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On Hock Lian Seng Holdings’s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. But note: Hock Lian Seng Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Hock Lian Seng Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
