Today we'll look at Sin Ghee Huat Corporation Ltd. (SGX:B7K) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Sin Ghee Huat:
0.031 = S$2.7m ÷ (S$91m - S$5.0m) (Based on the trailing twelve months to June 2019.)
Therefore, Sin Ghee Huat has an ROCE of 3.1%.
See our latest analysis for Sin Ghee Huat
Is Sin Ghee Huat's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Sin Ghee Huat's ROCE appears to be substantially greater than the 2.2% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Sin Ghee Huat compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.3% available in government bonds. It is likely that there are more attractive prospects out there.
Sin Ghee Huat delivered an ROCE of 3.1%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Sin Ghee Huat's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. ROCE is only a point-in-time measure. You can check if Sin Ghee Huat has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.