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Today we'll look at Highway Holdings Limited (NASDAQ:HIHO) 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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.'
How Do You Calculate Return On Capital Employed?
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 Highway Holdings:
0.036 = US$365k ÷ (US$15m - US$5.2m) (Based on the trailing twelve months to December 2018.)
So, Highway Holdings has an ROCE of 3.6%.
Is Highway Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Highway Holdings's ROCE is meaningfully below the Machinery industry average of 11%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Highway Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
As we can see, Highway Holdings currently has an ROCE of 3.6%, less than the 11% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. You can check if Highway Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Highway Holdings's Current Liabilities Impact 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Highway Holdings has total assets of US$15m and current liabilities of US$5.2m. As a result, its current liabilities are equal to approximately 34% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Highway Holdings's low ROCE is unappealing.
What We Can Learn From Highway Holdings's ROCE
So researching other companies may be a better use of your time. But note: Highway Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.