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Why We’re Not Keen On Lum Chang Holdings Limited’s (SGX:L19) 1.1% Return On Capital

Simply Wall St

Today we'll look at Lum Chang Holdings Limited (SGX:L19) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to 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.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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 Lum Chang Holdings:

0.011 = S$5.4m ÷ (S$689m - S$219m) (Based on the trailing twelve months to December 2019.)

So, Lum Chang Holdings has an ROCE of 1.1%.

Check out our latest analysis for Lum Chang Holdings

Is Lum Chang Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Lum Chang Holdings's ROCE appears to be significantly below the 3.9% average in the Construction industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Lum Chang 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.

Lum Chang Holdings's current ROCE of 1.1% is lower than its ROCE in the past, which was 5.0%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Lum Chang Holdings's ROCE compares to its industry. Click to see more on past growth.

SGX:L19 Past Revenue and Net Income May 19th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. If Lum Chang Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Lum Chang Holdings's Current Liabilities And Their Impact On 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Lum Chang Holdings has total assets of S$689m and current liabilities of S$219m. As a result, its current liabilities are equal to approximately 32% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Lum Chang Holdings's low ROCE is unappealing.

What We Can Learn From Lum Chang Holdings's ROCE

So researching other companies may be a better use of your time. Of course, you might also be able to find a better stock than Lum Chang Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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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.