Today we'll look at Deson Development International Holdings Limited (HKG:262) and reflect on its potential as an investment. 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. 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Deson Development International Holdings:
0.014 = HK$29m ÷ (HK$2.6b - HK$560m) (Based on the trailing twelve months to March 2019.)
Therefore, Deson Development International Holdings has an ROCE of 1.4%.
Does Deson Development International Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Deson Development International Holdings's ROCE is meaningfully below the Construction industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Deson Development International Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
Deson Development International Holdings delivered an ROCE of 1.4%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Deson Development International Holdings's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Deson Development International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Deson Development International Holdings's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Deson Development International Holdings has total liabilities of HK$560m and total assets of HK$2.6b. Therefore its current liabilities are equivalent to approximately 22% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Deson Development International Holdings's ROCE
While that is good to see, Deson Development International 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.
I will like Deson Development International Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 firstname.lastname@example.org. 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.