In This Article:
Today we'll look at Emperor Entertainment Hotel Limited (HKG:296) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Emperor Entertainment Hotel:
0.047 = HK$265m ÷ (HK$6.2b - HK$562m) (Based on the trailing twelve months to March 2019.)
So, Emperor Entertainment Hotel has an ROCE of 4.7%.
Check out our latest analysis for Emperor Entertainment Hotel
Is Emperor Entertainment Hotel's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Emperor Entertainment Hotel's ROCE is around the 4.9% average reported by the Hospitality industry. Putting aside Emperor Entertainment Hotel'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.
Emperor Entertainment Hotel's current ROCE of 4.7% is lower than its ROCE in the past, which was 8.8%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Emperor Entertainment Hotel's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Emperor Entertainment Hotel has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.