In This Article:
Today we are going to look at Yan Tat Group Holdings Limited (HKG:1480) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Yan Tat Group Holdings:
0.10 = HK$30m ÷ (HK$956m – HK$433m) (Based on the trailing twelve months to June 2018.)
So, Yan Tat Group Holdings has an ROCE of 10%.
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Does Yan Tat Group Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Yan Tat Group Holdings’s ROCE is fairly close to the Electronic industry average of 11%. Setting aside the industry comparison for now, Yan Tat Group Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
It is important to remember that ROCE shows past performance, and is 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. If Yan Tat Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Yan Tat Group Holdings’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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.