Today we'll evaluate E. Bon Holdings Limited (HKG:599) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 E. Bon Holdings:
0.041 = HK$22m ÷ (HK$740m - HK$191m) (Based on the trailing twelve months to September 2019.)
So, E. Bon Holdings has an ROCE of 4.1%.
Does E. Bon Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see E. Bon Holdings's ROCE is meaningfully below the Trade Distributors industry average of 7.6%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how E. Bon Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. Readers may wish to look for more rewarding investments.
E. Bon Holdings's current ROCE of 4.1% is lower than 3 years ago, when the company reported a 22% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how E. Bon Holdings's past growth compares to other companies.
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. You can check if E. Bon Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How E. Bon Holdings's Current Liabilities Impact 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. 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.
E. Bon Holdings has total liabilities of HK$191m and total assets of HK$740m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On E. Bon Holdings's ROCE
While that is good to see, E. Bon Holdings has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than E. Bon 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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.