Today we’ll look at Emperor Entertainment Hotel Limited (HKG:296) 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.
Firstly, we’ll go over how we 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. 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’.
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 Emperor Entertainment Hotel:
0.05 = HK$292m ÷ (HK$6.4b – HK$599m) (Based on the trailing twelve months to September 2019.)
So, Emperor Entertainment Hotel has an ROCE of 5.0%.
Is Emperor Entertainment Hotel’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Emperor Entertainment Hotel’s ROCE is fairly close to the Hospitality industry average of 5.1%. Aside from the industry comparison, Emperor Entertainment Hotel’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.
We can see that, Emperor Entertainment Hotel currently has an ROCE of 5.0%, less than the 7.1% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Emperor Entertainment Hotel’s ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Emperor Entertainment Hotel is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Emperor Entertainment Hotel’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 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.
Emperor Entertainment Hotel has total liabilities of HK$599m and total assets of HK$6.4b. As a result, its current liabilities are equal to approximately 9.3% of its total assets. Emperor Entertainment Hotel reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
The Bottom Line On Emperor Entertainment Hotel’s ROCE
If performance improves, then Emperor Entertainment Hotel may be an OK investment, especially at the right valuation. You might be able to find a better investment than Emperor Entertainment Hotel. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Emperor Entertainment Hotel better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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