In This Article:
Today we'll look at In Construction Holdings Limited (HKG:1500) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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. 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. 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'.
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 In Construction Holdings:
0.052 = HK$14m ÷ (HK$401m - HK$136m) (Based on the trailing twelve months to September 2019.)
So, In Construction Holdings has an ROCE of 5.2%.
See our latest analysis for In Construction Holdings
Is In Construction Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see In Construction Holdings's ROCE is meaningfully below the Construction industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how In Construction Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
In Construction Holdings's current ROCE of 5.2% is lower than 3 years ago, when the company reported a 32% ROCE. So investors might consider if it has had issues recently. The image below shows how In Construction Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If In Construction Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.