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Today we’ll evaluate Meilleure Health International Industry Group Limited (HKG:2327) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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’.
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 Meilleure Health International Industry Group:
0.024 = HK$16m ÷ (HK$1.2b – HK$270m) (Based on the trailing twelve months to June 2018.)
Therefore, Meilleure Health International Industry Group has an ROCE of 2.4%.
Is Meilleure Health International Industry Group’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Meilleure Health International Industry Group’s ROCE appears meaningfully below the 6.0% average reported by the Trade Distributors industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Meilleure Health International Industry Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. There are potentially more appealing investments elsewhere.
In our analysis, Meilleure Health International Industry Group’s ROCE appears to be 2.4%, compared to 3 years ago, when its ROCE was 0.3%. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Meilleure Health International Industry Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Meilleure Health International Industry Group’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) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Meilleure Health International Industry Group has total assets of HK$1.2b and current liabilities of HK$270m. As a result, its current liabilities are equal to approximately 22% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On Meilleure Health International Industry Group’s ROCE
That’s not a bad thing, however Meilleure Health International Industry Group has a weak ROCE and may not be an attractive investment. Of course you might be able to find a better stock than Meilleure Health International Industry Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.