Examining Emperor Watch & Jewellery Limited’s (HKG:887) Weak Return On Capital Employed

Simply Wall St

Sat, Jun 8, 2019, 8:26 PM

Today we'll evaluate Emperor Watch & Jewellery Limited (HKG:887) to determine whether it could have potential as an investment idea. 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.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?

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 Emperor Watch & Jewellery:

0.062 = HK$313m ÷ (HK$6.0b - HK$909m) (Based on the trailing twelve months to December 2018.)

Therefore, Emperor Watch & Jewellery has an ROCE of 6.2%.

View our latest analysis for Emperor Watch & Jewellery

Is Emperor Watch & Jewellery's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Emperor Watch & Jewellery's ROCE is meaningfully below the Specialty Retail industry average of 13%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Emperor Watch & Jewellery stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Emperor Watch & Jewellery reported an ROCE of 6.2% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving.

SEHK:887 Past Revenue and Net Income, June 9th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Emperor Watch & Jewellery is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.