Good Friend International Holdings Inc.’s (HKG:2398) Investment Returns Are Lagging Its Industry

Today we are going to look at Good Friend International Holdings Inc. (HKG:2398) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Good Friend International Holdings:

0.059 = CN¥52m ÷ (CN¥2.1b – CN¥1.2b) (Based on the trailing twelve months to June 2018.)

Therefore, Good Friend International Holdings has an ROCE of 5.9%.

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Is Good Friend International Holdings’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Good Friend International Holdings’s ROCE appears meaningfully below the 10% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Good Friend International Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

As we can see, Good Friend International Holdings currently has an ROCE of 5.9%, less than the 11% it reported 3 years ago. So investors might consider if it has had issues recently.

SEHK:2398 Last Perf January 22nd 19
SEHK:2398 Last Perf January 22nd 19

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Good Friend International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Good Friend International 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) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Good Friend International Holdings has total assets of CN¥2.1b and current liabilities of CN¥1.2b. As a result, its current liabilities are equal to approximately 59% of its total assets. Good Friend International Holdings has a fairly high level of current liabilities, meaningfully impacting its ROCE.

Our Take On Good Friend International Holdings’s ROCE

Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. 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.

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 editorial-team@simplywallst.com.