Are Affluent Foundation Holdings Limited’s (HKG:1757) High Returns Really That Great?

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Today we are going to look at Affluent Foundation Holdings Limited (HKG:1757) to see whether it might be an attractive investment prospect. 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. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the ‘return’ (pre-tax profit) a company generates from 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. 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 Affluent Foundation Holdings:

0.18 = HK$32m ÷ (HK$259m – HK$78m) (Based on the trailing twelve months to September 2018.)

Therefore, Affluent Foundation Holdings has an ROCE of 18%.

Check out our latest analysis for Affluent Foundation Holdings

Is Affluent Foundation Holdings’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Affluent Foundation Holdings’s ROCE is meaningfully better than the 13% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Affluent Foundation Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Affluent Foundation Holdings’s current ROCE of 18% is lower than 3 years ago, when the company reported a 61% ROCE. Therefore we wonder if the company is facing new headwinds.

SEHK:1757 Past Revenue and Net Income, June 14th 2019
SEHK:1757 Past Revenue and Net Income, June 14th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Affluent Foundation Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Affluent Foundation Holdings’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Affluent Foundation Holdings has total liabilities of HK$78m and total assets of HK$259m. As a result, its current liabilities are equal to approximately 30% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Affluent Foundation Holdings’s ROCE

This is good to see, and with a sound ROCE, Affluent Foundation Holdings could be worth a closer look. There might be better investments than Affluent Foundation 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 Affluent Foundation 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.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.