Today we are going to look at REM Group (Holdings) Limited (HKG:1750) 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.
First, 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.
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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for REM Group (Holdings):
0.13 = HK$26m ÷ (HK$269m - HK$65m) (Based on the trailing twelve months to June 2019.)
Therefore, REM Group (Holdings) has an ROCE of 13%.
Does REM Group (Holdings) Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, REM Group (Holdings)'s ROCE is meaningfully higher than the 8.1% average in the Electrical industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where REM Group (Holdings) sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, REM Group (Holdings) currently has an ROCE of 13%, less than the 44% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how REM Group (Holdings)'s past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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 REM Group (Holdings) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
REM Group (Holdings)'s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
REM Group (Holdings) has total assets of HK$269m and current liabilities of HK$65m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From REM Group (Holdings)'s ROCE
Overall, REM Group (Holdings) has a decent ROCE and could be worthy of further research. REM Group (Holdings) looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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