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Today we’ll look at Dragon Crown Group Holdings Limited (HKG:935) 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.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its 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.’
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 Dragon Crown Group Holdings:
0.072 = HK$93m ÷ (HK$1.3b – HK$53m) (Based on the trailing twelve months to December 2018.)
So, Dragon Crown Group Holdings has an ROCE of 7.2%.
Does Dragon Crown Group Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Dragon Crown Group Holdings’s ROCE is meaningfully below the Commercial Services industry average of 10.0%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Dragon Crown Group Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Dragon Crown Group Holdings’s current ROCE of 7.2% is lower than 3 years ago, when the company reported a 10.0% ROCE. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. If Dragon Crown Group Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Dragon Crown Group Holdings’s Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Dragon Crown Group Holdings has total liabilities of HK$53m and total assets of HK$1.3b. Therefore its current liabilities are equivalent to approximately 3.9% of its total assets. Dragon Crown Group Holdings reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
Our Take On Dragon Crown Group Holdings’s ROCE
Dragon Crown Group Holdings looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Dragon Crown Group Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Dragon Crown Group 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.