Today we are going to look at REM Group (Holdings) Limited (HKG:1750) to see whether it might be an attractive investment prospect. 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. And finally, we’ll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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.
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 REM Group (Holdings):
0.13 = HK$26m ÷ (HK$269m – HK$65m) (Based on the trailing twelve months to June 2019.)
Therefore, REM Group (Holdings) has an ROCE of 13%.
Is REM Group (Holdings)’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. REM Group (Holdings)’s ROCE appears to be substantially greater than the 8.1% average in the Electrical industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from REM Group (Holdings)’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
REM Group (Holdings)’s current ROCE of 13% is lower than its ROCE in the past, which was 44%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how REM Group (Holdings)’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. If REM Group (Holdings) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How REM Group (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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
REM Group (Holdings) has total assets of HK$269m and current liabilities of HK$65m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On REM Group (Holdings)’s ROCE
Overall, REM Group (Holdings) has a decent ROCE and could be worthy of further research. There might be better investments than REM Group (Holdings) 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.
I will like REM Group (Holdings) better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.