Today we’ll evaluate Bauhaus International (Holdings) Limited (HKG:483) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

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. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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 Bauhaus International (Holdings):

0.053 = HK$40m ÷ (HK$938m – HK$189m) (Based on the trailing twelve months to September 2018.)

So, Bauhaus International (Holdings) has an ROCE of 5.3%.

View our latest analysis for Bauhaus International (Holdings)

Is Bauhaus International (Holdings)’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Bauhaus International (Holdings)’s ROCE appears meaningfully below the 9.5% average reported by the Luxury industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Bauhaus International (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, Bauhaus International (Holdings) currently has an ROCE of 5.3%, less than the 14% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.

It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. If Bauhaus International (Holdings) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.