Today we’ll evaluate SG Group Holdings Limited (HKG:8442) 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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 SG Group Holdings:
0.31 = HK$31m ÷ (HK$130m – HK$35m) (Based on the trailing twelve months to October 2018.)
Therefore, SG Group Holdings has an ROCE of 31%.
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Is SG Group Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, SG Group Holdings’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, SG Group Holdings’s ROCE currently appears to be excellent.
SG Group Holdings’s current ROCE of 31% is lower than its ROCE in the past, which was 90%, 3 years ago. So investors might consider if it has had issues recently.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. You can check if SG Group Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
SG Group Holdings’s Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
SG Group Holdings has total assets of HK$130m and current liabilities of HK$35m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From SG Group Holdings’s ROCE
Low current liabilities and high ROCE is a good combination, making SG Group Holdings look quite interesting. But note: SG Group Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 firstname.lastname@example.org.