What Can We Make Of King's Flair International (Holdings) Limited’s (HKG:6822) High Return On Capital?

Today we'll evaluate King's Flair International (Holdings) Limited (HKG:6822) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. 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?

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 King's Flair International (Holdings):

0.21 = HK$146m ÷ (HK$1.1b - HK$388m) (Based on the trailing twelve months to December 2018.)

Therefore, King's Flair International (Holdings) has an ROCE of 21%.

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Does King's Flair International (Holdings) Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. King's Flair International (Holdings)'s ROCE appears to be substantially greater than the 9.3% average in the Consumer Durables industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, King's Flair International (Holdings)'s ROCE is currently very good.

King's Flair International (Holdings)'s current ROCE of 21% is lower than its ROCE in the past, which was 33%, 3 years ago. Therefore we wonder if the company is facing new headwinds.

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 King's Flair International (Holdings)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do King's Flair International (Holdings)'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 counter this, investors can check if a company has high current liabilities relative to total assets.

King's Flair International (Holdings) has total liabilities of HK$388m and total assets of HK$1.1b. As a result, its current liabilities are equal to approximately 36% of its total assets. A medium level of current liabilities boosts King's Flair International (Holdings)'s ROCE somewhat.

Our Take On King's Flair International (Holdings)'s ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. King's Flair International (Holdings) shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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 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.