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Today we’ll look at Milestone Builder Holdings Limited (HKG:1667) 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.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
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 Milestone Builder Holdings:
0.18 = HK$22m ÷ (HK$392m – HK$269m) (Based on the trailing twelve months to September 2018.)
So, Milestone Builder Holdings has an ROCE of 18%.
Does Milestone Builder Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Milestone Builder Holdings’s ROCE is meaningfully higher than the 14% average in the Construction industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Milestone Builder Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Milestone Builder Holdings’s current ROCE of 18% is lower than 3 years ago, when the company reported a 61% ROCE. This makes us wonder if the business is facing new challenges.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is Milestone Builder Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Milestone Builder Holdings’s Current Liabilities Skew 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Milestone Builder Holdings has total assets of HK$392m and current liabilities of HK$269m. As a result, its current liabilities are equal to approximately 69% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From Milestone Builder Holdings’s ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Of course you might be able to find a better stock than Milestone Builder Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.