In This Article:
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Today we'll look at Tan Chong International Limited (HKG:693) and reflect on its potential as an investment. 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 of all, we'll work out how to 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.
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. 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'.
How Do You Calculate Return On Capital Employed?
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 Tan Chong International:
0.071 = HK$972m ÷ (HK$18b - HK$4.6b) (Based on the trailing twelve months to December 2018.)
Therefore, Tan Chong International has an ROCE of 7.1%.
See our latest analysis for Tan Chong International
Is Tan Chong International's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Tan Chong International's ROCE is fairly close to the Retail Distributors industry average of 7.1%. Setting aside the industry comparison for now, Tan Chong International's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
In our analysis, Tan Chong International's ROCE appears to be 7.1%, compared to 3 years ago, when its ROCE was 5.0%. This makes us wonder if the company is improving.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Tan Chong International? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.