Today we'll look at Gain Plus Holdings Limited (HKG:8522) 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, 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.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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.'
How Do You Calculate Return On Capital Employed?
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 Gain Plus Holdings:
0.34 = HK$54m ÷ (HK$282m - HK$122m) (Based on the trailing twelve months to June 2019.)
Therefore, Gain Plus Holdings has an ROCE of 34%.
See our latest analysis for Gain Plus Holdings
Does Gain Plus Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Gain Plus Holdings's ROCE is meaningfully better than the 12% average in the Construction industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Gain Plus Holdings's ROCE currently appears to be excellent.
We can see that , Gain Plus Holdings currently has an ROCE of 34%, less than the 51% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Gain Plus Holdings's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. How cyclical is Gain Plus Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Gain Plus Holdings's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.