In This Article:
Today we'll look at Precious Dragon Technology Holdings Limited (HKG:1861) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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. 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'.
How Do You Calculate Return On Capital Employed?
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 Precious Dragon Technology Holdings:
0.16 = HK$50m ÷ (HK$421m - HK$102m) (Based on the trailing twelve months to June 2019.)
Therefore, Precious Dragon Technology Holdings has an ROCE of 16%.
Check out our latest analysis for Precious Dragon Technology Holdings
Is Precious Dragon Technology Holdings's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Precious Dragon Technology Holdings's ROCE is meaningfully higher than the 12% average in the Chemicals industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Precious Dragon Technology Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Precious Dragon Technology Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. You can check if Precious Dragon Technology Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.