In This Article:
Today we are going to look at Lonking Holdings Limited (HKG:3339) to see whether it might be an attractive investment prospect. 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. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Lonking Holdings:
0.17 = CN¥1.3b ÷ (CN¥14b – CN¥5.2b) (Based on the trailing twelve months to June 2018.)
Therefore, Lonking Holdings has an ROCE of 17%.
See our latest analysis for Lonking Holdings
Is Lonking Holdings’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Lonking Holdings’s ROCE is meaningfully better than the 10% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Lonking Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Lonking Holdings currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 6.3%. This makes us think about whether the company has been reinvesting shrewdly.
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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Lonking Holdings’s 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.