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Today we’ll look at Clifford Modern Living Holdings Limited (HKG:3686) and reflect on its potential as an investment. 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is 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. 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?
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 Clifford Modern Living Holdings:
0.31 = CN¥101m ÷ (CN¥442m – CN¥117m) (Based on the trailing twelve months to December 2018.)
Therefore, Clifford Modern Living Holdings has an ROCE of 31%.
Is Clifford Modern Living Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Clifford Modern Living Holdings’s ROCE is meaningfully better than the 3.7% average in the Industrials industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Clifford Modern Living Holdings’s ROCE in absolute terms currently looks quite high.
As we can see, Clifford Modern Living Holdings currently has an ROCE of 31%, less than the 55% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. How cyclical is Clifford Modern Living Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Clifford Modern Living 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Clifford Modern Living Holdings has total liabilities of CN¥117m and total assets of CN¥442m. As a result, its current liabilities are equal to approximately 26% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
Our Take On Clifford Modern Living Holdings’s ROCE
With low current liabilities and a high ROCE, Clifford Modern Living Holdings could be worthy of further investigation. There might be better investments than Clifford Modern Living 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 Clifford Modern Living 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 firstname.lastname@example.org. 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.