Today we'll look at Kingworld Medicines Group Limited (HKG:1110) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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'.
How Do You Calculate Return On Capital Employed?
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 Kingworld Medicines Group:
0.10 = CN¥73m ÷ (CN¥1.2b - CN¥514m) (Based on the trailing twelve months to June 2019.)
Therefore, Kingworld Medicines Group has an ROCE of 10%.
Is Kingworld Medicines Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Kingworld Medicines Group's ROCE is meaningfully higher than the 8.3% average in the Healthcare industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Kingworld Medicines Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Kingworld Medicines Group currently has an ROCE of 10%, compared to its ROCE of 8.1% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Kingworld Medicines Group's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. How cyclical is Kingworld Medicines Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Kingworld Medicines Group's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Kingworld Medicines Group has total assets of CN¥1.2b and current liabilities of CN¥514m. Therefore its current liabilities are equivalent to approximately 42% of its total assets. Kingworld Medicines Group has a medium level of current liabilities, which would boost the ROCE.
Our Take On Kingworld Medicines Group's ROCE
Kingworld Medicines Group's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than Kingworld Medicines Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Kingworld Medicines Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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