Today we’ll look at Sun.King Power Electronics Group Limited (HKG:580) and reflect on its potential as an investment. 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Sun.King Power Electronics Group:
0.13 = CN¥221m ÷ (CN¥2.5b – CN¥809m) (Based on the trailing twelve months to December 2018.)
So, Sun.King Power Electronics Group has an ROCE of 13%.
Is Sun.King Power Electronics Group’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Sun.King Power Electronics Group’s ROCE is meaningfully higher than the 10.0% average in the Electrical industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Sun.King Power Electronics Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Sun.King Power Electronics Group’s ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 8.6%. This makes us wonder if the company is improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Sun.King Power Electronics Group.
How Sun.King Power Electronics Group’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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Sun.King Power Electronics Group has total liabilities of CN¥809m and total assets of CN¥2.5b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. Sun.King Power Electronics Group has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Sun.King Power Electronics Group’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 Sun.King Power Electronics Group 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 email@example.com. 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.