Today we are going to look at Dragon Rise Group Holdings Limited (HKG:6829) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. 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 Dragon Rise Group Holdings:
0.043 = HK$13m ÷ (HK$330m – HK$37m) (Based on the trailing twelve months to March 2019.)
Therefore, Dragon Rise Group Holdings has an ROCE of 4.3%.
Is Dragon Rise Group Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Dragon Rise Group Holdings’s ROCE appears meaningfully below the 12% average reported by the Construction industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Dragon Rise Group Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.
Dragon Rise Group Holdings’s current ROCE of 4.3% is lower than 3 years ago, when the company reported a 43% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Dragon Rise Group Holdings’s ROCE compares to its industry.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Dragon Rise Group Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Dragon Rise Group Holdings’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Dragon Rise Group Holdings has total liabilities of HK$37m and total assets of HK$330m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Dragon Rise Group Holdings’s ROCE
That’s not a bad thing, however Dragon Rise Group Holdings has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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