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Today we are going to look at Yip’s Chemical Holdings Limited (HKG:408) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Yip’s Chemical Holdings:
0.095 = HK$420m ÷ (HK$8.5b – HK$3.5b) (Based on the trailing twelve months to June 2018.)
So, Yip’s Chemical Holdings has an ROCE of 9.5%.
View our latest analysis for Yip’s Chemical Holdings
Does Yip’s Chemical Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Yip’s Chemical Holdings’s ROCE is fairly close to the Chemicals industry average of 11%. Aside from the industry comparison, Yip’s Chemical Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Our data shows that Yip’s Chemical Holdings currently has an ROCE of 9.5%, compared to its ROCE of 6.6% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is Yip’s Chemical Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.