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Why Sunfonda Group Holdings Limited’s (HKG:1771) Use Of Investor Capital Doesn’t Look Great

Simply Wall St

Today we'll evaluate Sunfonda Group Holdings Limited (HKG:1771) 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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. 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?

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 Sunfonda Group Holdings:

0.089 = CN¥201m ÷ (CN¥4.9b - CN¥2.6b) (Based on the trailing twelve months to June 2019.)

So, Sunfonda Group Holdings has an ROCE of 8.9%.

See our latest analysis for Sunfonda Group Holdings

Does Sunfonda Group Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Sunfonda Group Holdings's ROCE appears to be significantly below the 12% average in the Specialty Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Sunfonda Group Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

You can see in the image below how Sunfonda Group Holdings's ROCE compares to its industry. Click to see more on past growth.

SEHK:1771 Past Revenue and Net Income, October 14th 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. You can check if Sunfonda Group Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Sunfonda Group Holdings'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. 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.

Sunfonda Group Holdings has total liabilities of CN¥2.6b and total assets of CN¥4.9b. As a result, its current liabilities are equal to approximately 54% of its total assets. With a high level of current liabilities, Sunfonda Group Holdings will experience a boost to its ROCE.

The Bottom Line On Sunfonda Group Holdings's ROCE

Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. You might be able to find a better investment than Sunfonda Group Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.