Should You Like KangLi International Holdings Limited’s (HKG:6890) High Return On Capital Employed?

Jonathon Baker

Sun, Feb 17, 2019, 7:39 PM

Today we’ll evaluate KangLi International Holdings Limited (HKG:6890) 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 KangLi International Holdings:

0.21 = CN¥102m ÷ (CN¥1.3b – CN¥821m) (Based on the trailing twelve months to December 2017.)

So, KangLi International Holdings has an ROCE of 21%.

See our latest analysis for KangLi International Holdings

Does KangLi International Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, KangLi International Holdings’s ROCE is meaningfully higher than the 11% average in the Metals and Mining 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. Regardless of the industry comparison, in absolute terms, KangLi International Holdings’s ROCE currently appears to be excellent.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Remember that most companies like KangLi International Holdings are cyclical businesses. You can check if KangLi International Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.