Why We’re Not Impressed By Jiahua Stores Holdings Limited’s (HKG:602) 3.4% ROCE

Alvin Rowe

Wed, Feb 6, 2019, 8:23 PM

Today we are going to look at Jiahua Stores Holdings Limited (HKG:602) to see whether it might be an attractive investment prospect. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding 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. All else being equal, a better business will have a higher ROCE. 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’.

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Jiahua Stores Holdings:

0.034 = CN¥43m ÷ (CN¥928m – CN¥307m) (Based on the trailing twelve months to June 2018.)

So, Jiahua Stores Holdings has an ROCE of 3.4%.

Check out our latest analysis for Jiahua Stores Holdings

Does Jiahua Stores Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Jiahua Stores Holdings’s ROCE is meaningfully below the Consumer Retailing industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Jiahua Stores Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

Jiahua Stores Holdings’s current ROCE of 3.4% is lower than 3 years ago, when the company reported a 15% ROCE. So investors might consider if it has had issues recently.

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 Jiahua Stores Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.