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Today we are going to look at Power Assets Holdings Limited (HKG:6) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. All else being equal, a better business will have a higher ROCE. 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'.
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 Power Assets Holdings:
0.015 = HK$1.3b ÷ (HK$91b - HK$4.1b) (Based on the trailing twelve months to December 2018.)
Therefore, Power Assets Holdings has an ROCE of 1.5%.
Check out our latest analysis for Power Assets Holdings
Is Power Assets Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Power Assets Holdings's ROCE is meaningfully below the Electric Utilities industry average of 5.2%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Power Assets Holdings'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.
We can see that , Power Assets Holdings currently has an ROCE of 1.5% compared to its ROCE 3 years ago, which was 1.1%. This makes us think the business might be improving. You can see in the image below how Power Assets Holdings's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Power Assets Holdings.