Are HengTen Networks Group Limited’s (HKG:136) High Returns Really That Great?

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Today we are going to look at HengTen Networks Group Limited (HKG:136) 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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’.

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 HengTen Networks Group:

0.13 = CN¥147m ÷ (CN¥1.4b – CN¥333m) (Based on the trailing twelve months to December 2018.)

Therefore, HengTen Networks Group has an ROCE of 13%.

See our latest analysis for HengTen Networks Group

Does HengTen Networks Group Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. HengTen Networks Group’s ROCE appears to be substantially greater than the 11% average in the Luxury industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from HengTen Networks Group’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

HengTen Networks Group reported an ROCE of 13% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving.

SEHK:136 Past Revenue and Net Income, May 15th 2019
SEHK:136 Past Revenue and Net Income, May 15th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. How cyclical is HengTen Networks Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do HengTen Networks Group’s Current Liabilities Skew 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

HengTen Networks Group has total assets of CN¥1.4b and current liabilities of CN¥333m. As a result, its current liabilities are equal to approximately 23% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On HengTen Networks Group’s ROCE

With that in mind, HengTen Networks Group’s ROCE appears pretty good. There might be better investments than HengTen Networks Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.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.