Today we’ll evaluate EVA Precision Industrial Holdings Limited (HKG:838) to determine whether it could have potential as an investment idea. 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. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 EVA Precision Industrial Holdings:
0.045 = HK$186m ÷ (HK$6.1b – HK$2.6b) (Based on the trailing twelve months to June 2018.)
So, 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. Using our data, EVA Precision Industrial Holdings’s ROCE appears to be significantly below the 10% average in the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how EVA Precision Industrial Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.
EVA Precision Industrial Holdings’s current ROCE of 4.5% is lower than 3 years ago, when the company reported a 10% ROCE. Therefore we wonder if the company is facing new headwinds.
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 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 EVA Precision Industrial Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How EVA Precision Industrial Holdings’s Current Liabilities Impact 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 liabilities of HK$2.6b and total assets of HK$6.1b. Therefore its current liabilities are equivalent to approximately 43% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, EVA Precision Industrial Holdings’s ROCE is concerning.
Our Take On EVA Precision Industrial Holdings’s ROCE
There are likely better investments out there. Of course you might be able to find a better stock than EVA Precision Industrial Holdings. 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.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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.