In This Article:
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Today we’ll look at Capital Estate Limited (HKG:193) and reflect on its potential as an investment. 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.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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’.
So, How Do We Calculate ROCE?
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 Capital Estate:
0.039 = HK$34m ÷ (HK$1.3b – HK$399m) (Based on the trailing twelve months to July 2018.)
So, Capital Estate has an ROCE of 3.9%.
Check out our latest analysis for Capital Estate
Does Capital Estate Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Capital Estate’s ROCE appears meaningfully below the 5.2% average reported by the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Capital Estate’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
Capital Estate delivered an ROCE of 3.9%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. You can check if Capital Estate has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.