Today we'll look at C Cheng Holdings Limited (HKG:1486) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. 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.
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. Generally speaking a higher ROCE is better. 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 C Cheng Holdings:
0.099 = HK$50m ÷ (HK$747m - HK$248m) (Based on the trailing twelve months to June 2019.)
Therefore, C Cheng Holdings has an ROCE of 9.9%.
Does C Cheng Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, C Cheng Holdings's ROCE appears to be significantly below the 16% average in the Professional Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how C Cheng Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
C Cheng Holdings's current ROCE of 9.9% is lower than its ROCE in the past, which was 17%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how C Cheng 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. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If C Cheng Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How C Cheng Holdings's Current Liabilities Impact 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.
C Cheng Holdings has current liabilities of HK$248m and total assets of HK$747m. As a result, its current liabilities are equal to approximately 33% of its total assets. C Cheng Holdings has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On C Cheng Holdings's ROCE
C Cheng Holdings's ROCE does look good, but the level of current liabilities also contribute to that. C Cheng 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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