Today we’ll evaluate Speed Apparel Holding Limited (HKG:8183) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting 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. 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’.
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 Speed Apparel Holding:
0.31 = HK$19m ÷ (HK$199m – HK$103m) (Based on the trailing twelve months to September 2018.)
So, Speed Apparel Holding has an ROCE of 31%.
Is Speed Apparel Holding’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Speed Apparel Holding’s ROCE is meaningfully higher than the 9.4% average in the Luxury industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Speed Apparel Holding’s ROCE currently appears to be excellent.
Speed Apparel Holding’s current ROCE of 31% is lower than its ROCE in the past, which was 63%, 3 years ago. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 Speed Apparel Holding is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Speed Apparel Holding’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Speed Apparel Holding has total liabilities of HK$103m and total assets of HK$199m. Therefore its current liabilities are equivalent to approximately 52% of its total assets. Speed Apparel Holding boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On Speed Apparel Holding’s ROCE
In my book, this business could be worthy of further research. You might be able to find a better buy than Speed Apparel Holding. 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).
I will like Speed Apparel Holding better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 firstname.lastname@example.org.