In This Article:
Today we'll evaluate KNT Holdings Limited (HKG:1025) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we 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 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 KNT Holdings:
0.33 = HK$42m ÷ (HK$171m - HK$42m) (Based on the trailing twelve months to March 2019.)
So, KNT Holdings has an ROCE of 33%.
Check out our latest analysis for KNT Holdings
Does KNT Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. KNT Holdings's ROCE appears to be substantially greater than the 9.5% average in the Luxury 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, KNT Holdings's ROCE currently appears to be excellent.
KNT Holdings's current ROCE of 33% is lower than 3 years ago, when the company reported a 62% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how KNT Holdings's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If KNT Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
KNT Holdings's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.