Today we’ll evaluate HengTen Networks Group Limited (HKG:136) to determine whether it could have potential as an investment idea. 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. Then we’ll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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 HengTen Networks Group:
0.21 = CN¥118m ÷ (CN¥1.4b – CN¥364m) (Based on the trailing twelve months to June 2018.)
So, HengTen Networks Group has an ROCE of 21%.
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Does HengTen Networks Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that HengTen Networks Group’s ROCE is meaningfully better than the 9.4% average in the Luxury 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. Regardless of the industry comparison, in absolute terms, HengTen Networks Group’s ROCE currently appears to be excellent.
HengTen Networks Group delivered an ROCE of 21%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If HengTen Networks Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do HengTen Networks Group’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
HengTen Networks Group has total liabilities of CN¥364m and total assets of CN¥1.4b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
What We Can Learn From HengTen Networks Group’s ROCE
With low current liabilities and a high ROCE, HengTen Networks Group could be worthy of further investigation. But note: HengTen Networks Group may not be the best stock to buy. 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.