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Today we'll look at Keong Hong Holdings Limited (SGX:5TT) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Keong Hong Holdings:
0.038 = S$12m ÷ (S$474m - S$167m) (Based on the trailing twelve months to March 2019.)
Therefore, Keong Hong Holdings has an ROCE of 3.8%.
Check out our latest analysis for Keong Hong Holdings
Is Keong Hong Holdings's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Keong Hong Holdings's ROCE is fairly close to the Construction industry average of 4.3%. Regardless of how Keong Hong Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
As we can see, Keong Hong Holdings currently has an ROCE of 3.8%, less than the 12% it reported 3 years ago. So investors might consider if it has had issues recently.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Keong Hong Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Keong Hong Holdings's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.