Today we'll evaluate Topsports International Holdings Limited (HKG:6110) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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?
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 Topsports International Holdings:
0.64 = CN¥3.6b ÷ (CN¥16b - CN¥11b) (Based on the trailing twelve months to August 2019.)
Therefore, Topsports International Holdings has an ROCE of 64%.
Is Topsports International Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Topsports International Holdings's ROCE is meaningfully higher than the 12% average in the Specialty Retail 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. Putting aside its position relative to its industry for now, in absolute terms, Topsports International Holdings's ROCE is currently very good.
The image below shows how Topsports International Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Topsports International Holdings.
What Are Current Liabilities, And How Do They Affect Topsports International Holdings's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Topsports International Holdings has total assets of CN¥16b and current liabilities of CN¥11b. As a result, its current liabilities are equal to approximately 66% of its total assets. Topsports International Holdings boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On Topsports International Holdings's ROCE
So we would be interested in doing more research here -- there may be an opportunity! Topsports International Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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.
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