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Today we'll look at Royal Deluxe Holdings Limited (HKG:3789) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 Royal Deluxe Holdings:
0.23 = HK$51m ÷ (HK$367m - HK$147m) (Based on the trailing twelve months to March 2019.)
Therefore, Royal Deluxe Holdings has an ROCE of 23%.
Check out our latest analysis for Royal Deluxe Holdings
Is Royal Deluxe Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Royal Deluxe Holdings's ROCE is meaningfully better than the 12% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Royal Deluxe Holdings's ROCE is currently very good.
Royal Deluxe Holdings's current ROCE of 23% is lower than its ROCE in the past, which was 52%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Royal Deluxe Holdings's ROCE compares to its industry, and you can click it to see more detail on its 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. ROCE is, after all, simply a snap shot of a single year. You can check if Royal Deluxe Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.