Today we are going to look at New Silkroad Culturaltainment Limited (HKG:472) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the 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'.
How Do You Calculate Return On Capital Employed?
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 New Silkroad Culturaltainment:
0.013 = HK$59m ÷ (HK$5.3b - HK$727m) (Based on the trailing twelve months to December 2018.)
So, New Silkroad Culturaltainment has an ROCE of 1.3%.
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Is New Silkroad Culturaltainment's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, New Silkroad Culturaltainment's ROCE appears meaningfully below the 3.7% average reported by the Beverage industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how New Silkroad Culturaltainment stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
New Silkroad Culturaltainment has an ROCE of 1.3%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if New Silkroad Culturaltainment has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How New Silkroad Culturaltainment's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
New Silkroad Culturaltainment has total liabilities of HK$727m and total assets of HK$5.3b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On New Silkroad Culturaltainment's ROCE
New Silkroad Culturaltainment has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than New Silkroad Culturaltainment. 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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If you spot an error that warrants correction, please contact the editor at email@example.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.