Today we'll evaluate Sing Lee Software (Group) Limited (HKG:8076) to determine whether it could have potential as an investment idea. 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. 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?
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 Sing Lee Software (Group):
0.36 = CN¥43m ÷ (CN¥160m - CN¥38m) (Based on the trailing twelve months to September 2019.)
Therefore, Sing Lee Software (Group) has an ROCE of 36%.
Is Sing Lee Software (Group)'s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Sing Lee Software (Group)'s ROCE is meaningfully better than the 9.4% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Sing Lee Software (Group)'s ROCE currently appears to be excellent.
Sing Lee Software (Group) has an ROCE of 36%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how Sing Lee Software (Group)'s ROCE compares to its industry. Click to see more on past growth.
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. How cyclical is Sing Lee Software (Group)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Sing Lee Software (Group)'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Sing Lee Software (Group) has total liabilities of CN¥38m and total assets of CN¥160m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
Our Take On Sing Lee Software (Group)'s ROCE
Low current liabilities and high ROCE is a good combination, making Sing Lee Software (Group) look quite interesting. Sing Lee Software (Group) 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.
There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.
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