Today we’ll look at Ngai Hing Hong Company Limited (HKG:1047) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
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 Ngai Hing Hong:
0.081 = HK$41m ÷ (HK$1.1b – HK$556m) (Based on the trailing twelve months to December 2018.)
Therefore, Ngai Hing Hong has an ROCE of 8.1%.
Does Ngai Hing Hong Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Ngai Hing Hong’s ROCE is meaningfully below the Chemicals industry average of 11%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Ngai Hing Hong’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
We can see that, Ngai Hing Hong currently has an ROCE of 8.1% compared to its ROCE 3 years ago, which was 4.4%. This makes us wonder if the company is improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Ngai Hing Hong is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Ngai Hing Hong’s Current Liabilities Impact 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.
Ngai Hing Hong has total liabilities of HK$556m and total assets of HK$1.1b. Therefore its current liabilities are equivalent to approximately 52% of its total assets. Ngai Hing Hong has a fairly high level of current liabilities, meaningfully impacting its ROCE.
The Bottom Line On Ngai Hing Hong’s ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. You might be able to find a better investment than Ngai Hing Hong. 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).
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 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.