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Today we’ll evaluate Royale Furniture Holdings Limited (HKG:1198) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting 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’.
How Do You Calculate Return On Capital Employed?
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 Royale Furniture Holdings:
0.026 = HK$50m ÷ (HK$2.3b – HK$560m) (Based on the trailing twelve months to June 2018.)
So, Royale Furniture Holdings has an ROCE of 2.6%.
See our latest analysis for Royale Furniture Holdings
Is Royale Furniture Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Royale Furniture Holdings’s ROCE appears to be significantly below the 9.8% average in the Consumer Durables industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Royale Furniture Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
Royale Furniture Holdings reported an ROCE of 2.6% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.
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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Royale Furniture Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.