Today we are going to look at Tak Lee Machinery Holdings Limited (HKG:8142) 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, 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Tak Lee Machinery Holdings:
0.21 = HK$73m ÷ (HK$496m – HK$146m) (Based on the trailing twelve months to January 2019.)
Therefore, Tak Lee Machinery Holdings has an ROCE of 21%.
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Is Tak Lee Machinery Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. Tak Lee Machinery Holdings’s ROCE appears to be substantially greater than the 6.6% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Tak Lee Machinery Holdings’s ROCE currently appears to be excellent.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. How cyclical is Tak Lee Machinery Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Tak Lee Machinery Holdings’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Tak Lee Machinery Holdings has total assets of HK$496m and current liabilities of HK$146m. Therefore its current liabilities are equivalent to approximately 29% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
Our Take On Tak Lee Machinery Holdings’s ROCE
This is good to see, and with such a high ROCE, Tak Lee Machinery Holdings may be worth a closer look. Tak Lee Machinery Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.