In This Article:
Today we’ll evaluate SCUD Group Limited (HKG:1399) to determine whether it could have potential as an investment idea. 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 SCUD Group:
0.06 = CN¥60m ÷ (CN¥4.5b – CN¥3.5b) (Based on the trailing twelve months to June 2018.)
Therefore, SCUD Group has an ROCE of 6.0%.
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Does SCUD Group Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see SCUD Group’s ROCE is around the 7.0% average reported by the Electrical industry. Separate from how SCUD Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
As we can see, SCUD Group currently has an ROCE of 6.0% compared to its ROCE 3 years ago, which was 2.7%. This makes us think the business might be improving.
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. You can check if SCUD Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How SCUD Group’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.