In This Article:
Today we’ll evaluate Auto Italia Holdings Limited (HKG:720) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. 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 Auto Italia Holdings:
0.058 = HK$55m ÷ (HK$584m – HK$80m) (Based on the trailing twelve months to June 2018.)
So, Auto Italia Holdings has an ROCE of 5.8%.
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Does Auto Italia Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Auto Italia Holdings’s ROCE appears to be significantly below the 13% average in the Specialty Retail industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Auto Italia Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
As we can see, Auto Italia Holdings currently has an ROCE of 5.8% compared to its ROCE 3 years ago, which was 3.3%. 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. 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, after all, simply a snap shot of a single year. If Auto Italia Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.