Today we’ll look at Hi Sun Technology (China) Limited (HKG:818) and reflect on its potential as an investment. 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Hi Sun Technology (China):
0.12 = HK$585m ÷ (HK$7.3b – HK$2.3b) (Based on the trailing twelve months to June 2019.)
Therefore, Hi Sun Technology (China) has an ROCE of 12%.
Does Hi Sun Technology (China) Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Hi Sun Technology (China)’s ROCE appears to be around the 11% average of the IT industry. Separate from Hi Sun Technology (China)’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Hi Sun Technology (China) currently has an ROCE of 12% compared to its ROCE 3 years ago, which was 2.2%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Hi Sun Technology (China)’s past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Hi Sun Technology (China).
How Hi Sun Technology (China)’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Hi Sun Technology (China) has total liabilities of HK$2.3b and total assets of HK$7.3b. As a result, its current liabilities are equal to approximately 32% of its total assets. Hi Sun Technology (China) has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Hi Sun Technology (China)’s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Hi Sun Technology (China) 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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