Today we’ll evaluate Vipshop Holdings Limited (NYSE:VIPS) 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.
Firstly, we’ll go over how we calculate ROCE. 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.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. 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?
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 Vipshop Holdings:
0.13 = CN¥2.5b ÷ (CN¥36b – CN¥17b) (Based on the trailing twelve months to March 2019.)
So, Vipshop Holdings has an ROCE of 13%.
Is Vipshop Holdings’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Vipshop Holdings’s ROCE is meaningfully higher than the 8.9% average in the Online 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. Regardless of where Vipshop Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that , Vipshop Holdings currently has an ROCE of 13%, less than the 27% it reported 3 years ago. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Vipshop Holdings.
Vipshop Holdings’s Current Liabilities And Their Impact On 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Vipshop Holdings has total liabilities of CN¥17b and total assets of CN¥36b. As a result, its current liabilities are equal to approximately 47% of its total assets. With this level of current liabilities, Vipshop Holdings’s ROCE is boosted somewhat.
The Bottom Line On Vipshop Holdings’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. There might be better investments than Vipshop Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.