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Here’s why Playmates Holdings Limited’s (HKG:635) Returns On Capital Matters So Much

Simply Wall St

Today we are going to look at Playmates Holdings Limited (HKG:635) to see whether it might be an attractive investment prospect. 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.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding 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. 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'.

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 Playmates Holdings:

0.027 = HK$196m ÷ (HK$8.1b - HK$783m) (Based on the trailing twelve months to June 2019.)

So, Playmates Holdings has an ROCE of 2.7%.

Check out our latest analysis for Playmates Holdings

Does Playmates Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Playmates Holdings's ROCE appears meaningfully below the 9.6% average reported by the Leisure industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Playmates 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.

Playmates Holdings's current ROCE of 2.7% is lower than 3 years ago, when the company reported a 7.3% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Playmates Holdings's past growth compares to other companies.

SEHK:635 Past Revenue and Net Income, August 23rd 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. If Playmates Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Playmates Holdings's Current Liabilities Impact Its 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.

Playmates Holdings has total assets of HK$8.1b and current liabilities of HK$783m. As a result, its current liabilities are equal to approximately 9.7% of its total assets. Playmates Holdings has a low level of current liabilities, which have a negligible impact on its already low ROCE.

The Bottom Line On Playmates Holdings'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 Playmates Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Playmates 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 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.