Today we'll look at Thelloy Development Group Limited (HKG:1546) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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'.
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 Thelloy Development Group:
0.44 = HK$60m ÷ (HK$233m - HK$96m) (Based on the trailing twelve months to September 2019.)
Therefore, Thelloy Development Group has an ROCE of 44%.
Is Thelloy Development Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Thelloy Development Group's ROCE is meaningfully higher than the 12% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Thelloy Development Group's ROCE is currently very good.
Our data shows that Thelloy Development Group currently has an ROCE of 44%, compared to its ROCE of 20% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Thelloy Development Group's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. If Thelloy Development Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Thelloy Development Group'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Thelloy Development Group has current liabilities of HK$96m and total assets of HK$233m. As a result, its current liabilities are equal to approximately 41% of its total assets. A medium level of current liabilities boosts Thelloy Development Group's ROCE somewhat.
The Bottom Line On Thelloy Development Group's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Thelloy Development Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.