In This Article:
Today we'll evaluate Hoe Leong Corporation Ltd. (SGX:H20) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Hoe Leong:
0.0053 = S$210k ÷ (S$70m - S$30m) (Based on the trailing twelve months to March 2019.)
So, Hoe Leong has an ROCE of 0.5%.
Check out our latest analysis for Hoe Leong
Does Hoe Leong Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Hoe Leong's ROCE appears meaningfully below the 2.3% average reported by the Trade Distributors industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Hoe Leong's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
Hoe Leong delivered an ROCE of 0.5%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can see in the image below how Hoe Leong'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. ROCE is, after all, simply a snap shot of a single year. You can check if Hoe Leong has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.