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Why Luen Thai Holdings Limited’s (HKG:311) Return On Capital Employed Is Impressive

Simply Wall St

Today we'll evaluate Luen Thai Holdings Limited (HKG:311) to determine whether it could have potential as an investment idea. 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. Then we'll determine how its current liabilities are affecting its ROCE.

What is 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. 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?

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 Luen Thai Holdings:

0.14 = US$35m ÷ (US$546m - US$294m) (Based on the trailing twelve months to June 2019.)

Therefore, Luen Thai Holdings has an ROCE of 14%.

Check out our latest analysis for Luen Thai Holdings

Does Luen Thai Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Luen Thai Holdings's ROCE appears to be substantially greater than the 9.5% average in the Luxury industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Luen Thai Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Luen Thai Holdings currently has an ROCE of 14%, compared to its ROCE of 7.4% 3 years ago. This makes us wonder if the company is improving. The image below shows how Luen Thai Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:311 Past Revenue and Net Income, September 30th 2019

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 Luen Thai Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do Luen Thai 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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Luen Thai Holdings has total assets of US$546m and current liabilities of US$294m. As a result, its current liabilities are equal to approximately 54% of its total assets. Luen Thai Holdings has a relatively high level of current liabilities, boosting its ROCE meaningfully.

Our Take On Luen Thai Holdings's ROCE

The ROCE would not look as appealing if the company had fewer current liabilities. Luen Thai Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.