In This Article:
Today we are going to look at REF Holdings Limited (HKG:1631) 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 of all, we'll work out how to calculate ROCE. 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 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. 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?
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 REF Holdings:
0.17 = HK$41m ÷ (HK$321m - HK$77m) (Based on the trailing twelve months to June 2019.)
So, REF Holdings has an ROCE of 17%.
View our latest analysis for REF Holdings
Is REF Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. REF Holdings's ROCE appears to be substantially greater than the 9.9% average in the Commercial Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where REF Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
REF Holdings's current ROCE of 17% is lower than 3 years ago, when the company reported a 63% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how REF Holdings's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If REF Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.