Why We Like Guan Chao Holdings Limited’s (HKG:1872) 22% Return On Capital Employed

Simply Wall St

Wed, Jun 5, 2019, 10:01 PM

Today we are going to look at Guan Chao Holdings Limited (HKG:1872) 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Guan Chao Holdings:

0.22 = S$11m ÷ (S$100m - S$53m) (Based on the trailing twelve months to December 2018.)

Therefore, Guan Chao Holdings has an ROCE of 22%.

View our latest analysis for Guan Chao Holdings

Does Guan Chao Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Guan Chao Holdings's ROCE is meaningfully better than the 13% average in the Specialty Retail industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Guan Chao Holdings's ROCE is currently very good.

Guan Chao Holdings's current ROCE of 22% is lower than its ROCE in the past, which was 44%, 3 years ago. So investors might consider if it has had issues recently.

SEHK:1872 Past Revenue and Net Income, June 6th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Guan Chao Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.