Today we’ll evaluate Affluent Foundation Holdings Limited (HKG:1757) to determine whether it could have potential as an investment idea. 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.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared 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. All else being equal, a better business will have a higher ROCE. In brief, ROCE is a useful tool, but it is not without drawbacks. 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 Affluent Foundation Holdings:
0.18 = HK$26m ÷ (HK$259m – HK$78m) (Based on the trailing twelve months to September 2018.)
So, Affluent Foundation Holdings has an ROCE of 18%.
Is Affluent Foundation Holdings’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Affluent Foundation Holdings’s ROCE appears to be substantially greater than the 13% 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. Regardless of where Affluent Foundation Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Affluent Foundation 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 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. You can check if Affluent Foundation Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Affluent Foundation Holdings’s Current Liabilities And Their Impact On 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 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) unfairly boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Affluent Foundation Holdings has total assets of HK$259m and current liabilities of HK$78m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Affluent Foundation Holdings’s ROCE
With that in mind, Affluent Foundation Holdings’s ROCE appears pretty good. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.
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.