In This Article:
Today we are going to look at Shing Chi Holdings Limited (HKG:1741) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Shing Chi Holdings:
0.29 = HK$26m ÷ (HK$248m – HK$155m) (Based on the trailing twelve months to September 2018.)
Therefore, Shing Chi Holdings has an ROCE of 29%.
Check out our latest analysis for Shing Chi Holdings
Is Shing Chi Holdings’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Shing Chi Holdings’s ROCE is meaningfully better than the 13% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Shing Chi Holdings’s ROCE in absolute terms currently looks quite high.
As we can see, Shing Chi Holdings currently has an ROCE of 29%, less than the 60% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Shing Chi Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Shing Chi Holdings’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.