In This Article:
Today we are going to look at Tan Chong International Limited (HKG:693) to see whether it might be an attractive investment prospect. 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 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 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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:
0.02 = HK$271m ÷ (HK$20b - HK$5.9b) (Based on the trailing twelve months to December 2019.)
Therefore, Tan Chong International has an ROCE of 2.0%.
Check out our latest analysis for Tan Chong International
Is Tan Chong International's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Tan Chong International's ROCE is meaningfully below the Retail Distributors industry average of 8.4%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Tan Chong International's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Tan Chong International's current ROCE of 2.0% is lower than 3 years ago, when the company reported a 3.9% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Tan Chong International's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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.