In This Article:
Today we'll look at Yongmao Holdings Limited (SGX:BKX) and reflect on its potential as an investment. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?
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 Yongmao Holdings:
0.15 = CN¥132m ÷ (CN¥1.7b - CN¥816m) (Based on the trailing twelve months to September 2019.)
So, Yongmao Holdings has an ROCE of 15%.
View our latest analysis for Yongmao Holdings
Is Yongmao Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Yongmao Holdings's ROCE is meaningfully higher than the 6.9% average in the Machinery industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Yongmao Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, Yongmao Holdings's ROCE appears to be 15%, compared to 3 years ago, when its ROCE was 7.9%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Yongmao Holdings's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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, after all, simply a snap shot of a single year. You can check if Yongmao Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Yongmao Holdings's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.