In This Article:
Today we'll look at Sheung Moon Holdings Limited (HKG:8523) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
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 Sheung Moon Holdings:
0.21 = HK$30m ÷ (HK$266m - HK$118m) (Based on the trailing twelve months to March 2019.)
So, Sheung Moon Holdings has an ROCE of 21%.
View our latest analysis for Sheung Moon Holdings
Is Sheung Moon Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Sheung Moon Holdings's ROCE is meaningfully higher than the 13% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Sheung Moon Holdings's ROCE currently appears to be excellent.
The image below shows how Sheung Moon Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. If Sheung Moon Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Sheung Moon Holdings's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.