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Today we’ll evaluate Shanshan Brand Management Co., Ltd. (HKG:1749) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Shanshan Brand Management:
0.21 = CN¥65m ÷ (CN¥1.1b – CN¥745m) (Based on the trailing twelve months to December 2018.)
So, Shanshan Brand Management has an ROCE of 21%.
Does Shanshan Brand Management Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Shanshan Brand Management’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. Regardless of the industry comparison, in absolute terms, Shanshan Brand Management’s ROCE currently appears to be excellent.
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. You can check if Shanshan Brand Management has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Shanshan Brand Management’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.
Shanshan Brand Management has total liabilities of CN¥745m and total assets of CN¥1.1b. Therefore its current liabilities are equivalent to approximately 71% of its total assets. Shanshan Brand Management boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On Shanshan Brand Management’s ROCE
In my book, this business could be worthy of further research. Shanshan Brand Management looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.