Today we’ll evaluate Bauhaus International (Holdings) Limited (HKG:483) 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.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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. 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?
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 Bauhaus International (Holdings):
0.053 = HK$40m ÷ (HK$938m – HK$189m) (Based on the trailing twelve months to September 2018.)
So, Bauhaus International (Holdings) has an ROCE of 5.3%.
Is Bauhaus International (Holdings)’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Bauhaus International (Holdings)’s ROCE appears meaningfully below the 9.3% average reported by the Luxury industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Bauhaus International (Holdings) stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Bauhaus International (Holdings)’s current ROCE of 5.3% is lower than its ROCE in the past, which was 14%, 3 years ago. This makes us wonder if the business is facing new challenges.
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. How cyclical is Bauhaus International (Holdings)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Bauhaus International (Holdings)’s Current Liabilities And Their Impact On 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.
Bauhaus International (Holdings) has total assets of HK$938m and current liabilities of HK$189m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Bauhaus International (Holdings)’s ROCE
With that in mind, we’re not overly impressed with Bauhaus International (Holdings)’s ROCE, so it may not be the most appealing prospect. You might be able to find a better buy than Bauhaus International (Holdings). If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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.