Today we'll evaluate WINDMILL Group Limited (HKG:1850) to determine whether it could have potential as an investment idea. 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.
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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 WINDMILL Group:
0.15 = HK$20m ÷ (HK$211m - HK$77m) (Based on the trailing twelve months to October 2019.)
So, WINDMILL Group has an ROCE of 15%.
Is WINDMILL Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. WINDMILL Group's ROCE appears to be substantially greater than the 11% average in the Commercial Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how WINDMILL Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
WINDMILL Group's current ROCE of 15% is lower than its ROCE in the past, which was 34%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how WINDMILL Group's past growth compares to other companies.
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. How cyclical is WINDMILL Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
WINDMILL Group's Current Liabilities And Their Impact On Its 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.
WINDMILL Group has total liabilities of HK$77m and total assets of HK$211m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. WINDMILL Group has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From WINDMILL Group's ROCE
WINDMILL Group's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than WINDMILL Group 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.
I will like WINDMILL Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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