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Today we are going to look at Theme International Holdings Limited (HKG:990) to see whether it might be an attractive investment prospect. 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.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. 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’.
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 Theme International Holdings:
0.15 = HK$107m ÷ (HK$1.8b – HK$1.1b) (Based on the trailing twelve months to December 2018.)
Therefore, Theme International Holdings has an ROCE of 15%.
Does Theme International Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Theme International Holdings’s ROCE appears to be substantially greater than the 5.8% average in the Trade Distributors industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Theme International Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Theme International Holdings has an ROCE of 15%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can check if Theme International Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Theme International 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Theme International Holdings has total liabilities of HK$1.1b and total assets of HK$1.8b. As a result, its current liabilities are equal to approximately 60% of its total assets. Theme International Holdings’s current liabilities are fairly high, which increases its ROCE significantly.
Our Take On Theme International Holdings’s ROCE
While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. Theme International 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.
I will like Theme International 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 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.