Today we'll look at Niraku GC Holdings, Inc. (HKG:1245) 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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'.

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 Niraku GC Holdings:

0.021 = JP¥1.5b ÷ (JP¥85b - JP¥12b) (Based on the trailing twelve months to September 2019.)

So, Niraku GC Holdings has an ROCE of 2.1%.

See our latest analysis for Niraku GC Holdings

Is Niraku GC Holdings's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Niraku GC Holdings's ROCE is meaningfully below the Hospitality industry average of 5.2%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Niraku GC Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. Readers may wish to look for more rewarding investments.

We can see that, Niraku GC Holdings currently has an ROCE of 2.1%, less than the 5.9% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Niraku GC Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. How cyclical is Niraku GC Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.