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Why Niraku GC Holdings, Inc.’s (HKG:1245) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll evaluate Niraku GC Holdings, Inc. (HKG:1245) 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.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?

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 Niraku GC Holdings:

0.033 = JP¥1.4b ÷ (JP¥54b - JP¥9.8b) (Based on the trailing twelve months to March 2019.)

Therefore, Niraku GC Holdings has an ROCE of 3.3%.

See our latest analysis for Niraku GC Holdings

Is Niraku GC Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Niraku GC Holdings's ROCE is meaningfully below the Hospitality industry average of 5.0%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Niraku GC Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.

You can click on the image below to see (in greater detail) how Niraku GC Holdings's past growth compares to other companies.

SEHK:1245 Past Revenue and Net Income, October 11th 2019

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if Niraku GC Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Niraku GC Holdings's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.

Niraku GC Holdings has total liabilities of JP¥9.8b and total assets of JP¥54b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

Our Take On Niraku GC Holdings's ROCE

While that is good to see, Niraku GC Holdings has a low ROCE and does not look attractive in this analysis. 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.