Why We Like Wah Sun Handbags International Holdings Limited’s (HKG:2683) 23% Return On Capital Employed

Today we’ll evaluate Wah Sun Handbags International Holdings Limited (HKG:2683) 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. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. Ultimately, it is a useful but imperfect metric. 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?

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 Wah Sun Handbags International Holdings:

0.23 = HK$49m ÷ (HK$434m – HK$215m) (Based on the trailing twelve months to September 2018.)

So, Wah Sun Handbags International Holdings has an ROCE of 23%.

Check out our latest analysis for Wah Sun Handbags International Holdings

Is Wah Sun Handbags International Holdings’s ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Wah Sun Handbags International Holdings’s ROCE is meaningfully higher 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, Wah Sun Handbags International Holdings’s ROCE currently appears to be excellent.

Wah Sun Handbags International Holdings’s current ROCE of 23% is lower than its ROCE in the past, which was 63%, 3 years ago. This makes us wonder if the business is facing new challenges.

SEHK:2683 Past Revenue and Net Income, April 2nd 2019
SEHK:2683 Past Revenue and Net Income, April 2nd 2019

When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is, after all, simply a snap shot of a single year. If Wah Sun Handbags International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Wah Sun Handbags International Holdings’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Wah Sun Handbags International Holdings has total liabilities of HK$215m and total assets of HK$434m. Therefore its current liabilities are equivalent to approximately 50% of its total assets. Wah Sun Handbags International Holdings has a medium level of current liabilities, boosting its ROCE somewhat.

What We Can Learn From Wah Sun Handbags International Holdings’s ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Wah Sun Handbags 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 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.