Today we'll evaluate BAIOO Family Interactive Limited (HKG:2100) 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. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding 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. 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.
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 BAIOO Family Interactive:
0.017 = CN¥27m ÷ (CN¥1.8b - CN¥176m) (Based on the trailing twelve months to June 2019.)
Therefore, BAIOO Family Interactive has an ROCE of 1.7%.
Is BAIOO Family Interactive's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, BAIOO Family Interactive's ROCE appears meaningfully below the 12% average reported by the Entertainment industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how BAIOO Family Interactive compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. Readers may wish to look for more rewarding investments.
In our analysis, BAIOO Family Interactive's ROCE appears to be 1.7%, compared to 3 years ago, when its ROCE was 0.03%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how BAIOO Family Interactive's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is BAIOO Family Interactive? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How BAIOO Family Interactive's Current Liabilities Impact 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.
BAIOO Family Interactive has total assets of CN¥1.8b and current liabilities of CN¥176m. Therefore its current liabilities are equivalent to approximately 9.9% of its total assets. BAIOO Family Interactive has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On BAIOO Family Interactive's ROCE
Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better investment than BAIOO Family Interactive. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 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. Thank you for reading.