Today we’ll evaluate Win Win Way Construction Holdings Ltd. (HKG:994) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Win Win Way Construction Holdings:
0.11 = HK$50m ÷ (HK$540m – HK$198m) (Based on the trailing twelve months to June 2018.)
So, Win Win Way Construction Holdings has an ROCE of 11%.
Is Win Win Way Construction Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Win Win Way Construction Holdings’s ROCE is meaningfully below the Construction industry average of 14%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Win Win Way Construction Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, Win Win Way Construction Holdings currently has an ROCE of 11%, less than the 30% it reported 3 years ago. So investors might consider if it has had issues recently.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. How cyclical is Win Win Way Construction Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Win Win Way Construction 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. 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.
Win Win Way Construction Holdings has total assets of HK$540m and current liabilities of HK$198m. As a result, its current liabilities are equal to approximately 37% of its total assets. Win Win Way Construction Holdings has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From Win Win Way Construction Holdings’s ROCE
Win Win Way Construction Holdings’s ROCE does look good, but the level of current liabilities also contribute to that. But note: Win Win Way Construction Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
Of course Win Win Way Construction Holdings may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.