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Why S&P International Holding Limited’s (HKG:1695) Return On Capital Employed Looks Uninspiring

Simply Wall St

Today we'll look at S&P International Holding Limited (HKG:1695) 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. Then we'll compare its ROCE 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. 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?

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 S&P International Holding:

0.049 = RM7.4m ÷ (RM162m - RM12m) (Based on the trailing twelve months to June 2019.)

Therefore, S&P International Holding has an ROCE of 4.9%.

Check out our latest analysis for S&P International Holding

Does S&P International Holding Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, S&P International Holding's ROCE appears to be significantly below the 10% average in the Food 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 S&P International Holding compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. There are potentially more appealing investments elsewhere.

S&P International Holding's current ROCE of 4.9% is lower than its ROCE in the past, which was 30%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how S&P International Holding's ROCE compares to its industry. Click to see more on past growth.

SEHK:1695 Past Revenue and Net Income, October 20th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 only a point-in-time measure. How cyclical is S&P International Holding? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

S&P International Holding'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

S&P International Holding has total assets of RM162m and current liabilities of RM12m. Therefore its current liabilities are equivalent to approximately 7.7% of its total assets. S&P International Holding has a low level of current liabilities, which have a negligible impact on its already low ROCE.

What We Can Learn From S&P International Holding's ROCE

Nevertheless, there are potentially more attractive companies to invest in. Of course, you might also be able to find a better stock than S&P International Holding. 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.

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 editorial-team@simplywallst.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.