Today we are going to look at Luks Group (Vietnam Holdings) Company Limited (HKG:366) to see whether it might be an attractive investment prospect. 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, 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 amount of pre-tax profits a company can generate from the capital employed 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.’

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 Luks Group (Vietnam Holdings):

0.028 = HK$85m ÷ (HK$2.8b – HK$248m) (Based on the trailing twelve months to June 2018.)

Therefore, Luks Group (Vietnam Holdings) has an ROCE of 2.8%.

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Is Luks Group (Vietnam Holdings)’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Luks Group (Vietnam Holdings)’s ROCE appears meaningfully below the 14% average reported by the Basic Materials industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Luks Group (Vietnam Holdings)’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

Luks Group (Vietnam Holdings)’s current ROCE of 2.8% is lower than its ROCE in the past, which was 4.3%, 3 years ago. So investors might consider if it has had issues recently.

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. You can check if Luks Group (Vietnam Holdings) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Luks Group (Vietnam 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Luks Group (Vietnam Holdings) has total assets of HK$2.8b and current liabilities of HK$248m. As a result, its current liabilities are equal to approximately 8.9% of its total assets. Luks Group (Vietnam Holdings) has a low level of current liabilities, which have a negligible impact on its already low ROCE.

Our Take On Luks Group (Vietnam Holdings)’s ROCE

Nonetheless, there may be better places to invest your capital. Of course you might be able to find a better stock than Luks Group (Vietnam Holdings). So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.