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Today we'll look at Koufu Group Limited (SGX:VL6) 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.
Firstly, 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?
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 Koufu Group:
0.14 = S$32m ÷ (S$333m - S$109m) (Based on the trailing twelve months to March 2019.)
Therefore, Koufu Group has an ROCE of 14%.
Check out our latest analysis for Koufu Group
Does Koufu Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Koufu Group's ROCE is meaningfully better than the 5.4% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Koufu Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Koufu Group's current ROCE of 14% is lower than its ROCE in the past, which was 22%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Koufu Group.
How Koufu Group's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.