Today we'll look at Shaw Brothers Holdings Limited (HKG:953) 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Shaw Brothers Holdings:
0.081 = CN¥35m ÷ (CN¥597m - CN¥166m) (Based on the trailing twelve months to December 2019.)
Therefore, Shaw Brothers Holdings has an ROCE of 8.1%.
Does Shaw Brothers Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Shaw Brothers Holdings's ROCE appears meaningfully below the 16% average reported by the Entertainment industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Shaw Brothers Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Shaw Brothers Holdings delivered an ROCE of 8.1%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how Shaw Brothers Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 Shaw Brothers Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Shaw Brothers Holdings's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Shaw Brothers Holdings has total assets of CN¥597m and current liabilities of CN¥166m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On Shaw Brothers Holdings's ROCE
That said, Shaw Brothers Holdings's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Shaw Brothers Holdings. 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.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.