Why We’re Not Keen On Yangtzekiang Garment Limited’s (HKG:294) 0.8% Return On Capital

Today we’ll look at Yangtzekiang Garment Limited (HKG:294) 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?

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 Yangtzekiang Garment:

0.008 = HK$12m ÷ (HK$1.3b – HK$131m) (Based on the trailing twelve months to September 2018.)

So, Yangtzekiang Garment has an ROCE of 0.8%.

Check out our latest analysis for Yangtzekiang Garment

Is Yangtzekiang Garment’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Yangtzekiang Garment’s ROCE is meaningfully below the Luxury industry average of 9.4%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Yangtzekiang Garment stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

Our data shows that Yangtzekiang Garment currently has an ROCE of 0.8%, compared to its ROCE of 0.5% 3 years ago. This makes us wonder if the company is improving.

SEHK:294 Last Perf January 25th 19
SEHK:294 Last Perf January 25th 19

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. If Yangtzekiang Garment is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Yangtzekiang Garment’s Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Yangtzekiang Garment has total assets of HK$1.3b and current liabilities of HK$131m. Therefore its current liabilities are equivalent to approximately 9.8% of its total assets. With barely any current liabilities, there is minimal impact on Yangtzekiang Garment’s admittedly low ROCE.

Our Take On Yangtzekiang Garment’s ROCE

Nevertheless, there are potentially more attractive companies to invest in. Of course you might be able to find a better stock than Yangtzekiang Garment. So you may wish to see this free collection of other companies that have grown earnings strongly.

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 editorial-team@simplywallst.com.