In This Article:
Today we are going to look at Lum Chang Holdings Limited (SGX:L19) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 Lum Chang Holdings:
0.0073 = S$3.7m ÷ (S$680m - S$174m) (Based on the trailing twelve months to June 2019.)
Therefore, Lum Chang Holdings has an ROCE of 0.7%.
View our latest analysis for Lum Chang Holdings
Does Lum Chang Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Lum Chang Holdings's ROCE is meaningfully below the Construction industry average of 4.4%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Lum Chang Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Lum Chang Holdings's current ROCE of 0.7% is lower than its ROCE in the past, which was 7.1%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Lum Chang Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Lum Chang Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.