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Today we are going to look at EVA Precision Industrial Holdings Limited (HKG:838) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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?
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 EVA Precision Industrial Holdings:
0.045 = HK$144m ÷ (HK$5.7b – HK$2.5b) (Based on the trailing twelve months to December 2018.)
Therefore, EVA Precision Industrial Holdings has an ROCE of 4.5%.
Does EVA Precision Industrial Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, EVA Precision Industrial Holdings’s ROCE appears meaningfully below the 10% average reported by the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside EVA Precision Industrial Holdings’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
As we can see, EVA Precision Industrial Holdings currently has an ROCE of 4.5%, less than the 7.8% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. If EVA Precision Industrial Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do EVA Precision Industrial Holdings’s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
EVA Precision Industrial Holdings has total assets of HK$5.7b and current liabilities of HK$2.5b. As a result, its current liabilities are equal to approximately 44% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, EVA Precision Industrial Holdings’s ROCE is concerning.
The Bottom Line On EVA Precision Industrial Holdings’s ROCE
This company may not be the most attractive investment prospect. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.
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.