In This Article:
Today we'll look at Capital Environment Holdings Limited (HKG:3989) 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. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. 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'.
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 Capital Environment Holdings:
0.062 = CN¥830m ÷ (CN¥16b - CN¥2.9b) (Based on the trailing twelve months to June 2019.)
So, Capital Environment Holdings has an ROCE of 6.2%.
See our latest analysis for Capital Environment Holdings
Is Capital Environment Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Capital Environment Holdings's ROCE appears meaningfully below the 11% average reported by the Commercial Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Capital Environment Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
We can see that, Capital Environment Holdings currently has an ROCE of 6.2%, less than the 17% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Capital Environment Holdings's ROCE compares to its industry. Click to see more on 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 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 Capital Environment Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.