Today we are going to look at Ten Pao Group Holdings Limited (HKG:1979) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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 Ten Pao Group Holdings:
0.28 = HK$217m ÷ (HK$2.1b - HK$1.3b) (Based on the trailing twelve months to June 2019.)
So, Ten Pao Group Holdings has an ROCE of 28%.
Does Ten Pao Group Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Ten Pao Group Holdings's ROCE is meaningfully better than the 8.1% average in the Electrical industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Ten Pao Group Holdings's ROCE currently appears to be excellent.
You can see in the image below how Ten Pao Group Holdings's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ten Pao Group Holdings.
Ten Pao 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Ten Pao Group Holdings has total liabilities of HK$1.3b and total assets of HK$2.1b. As a result, its current liabilities are equal to approximately 63% of its total assets. Ten Pao Group Holdings's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Ten Pao Group Holdings's ROCE
In my book, this business could be worthy of further research. There might be better investments than Ten Pao Group Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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. Thank you for reading.