Today we’ll evaluate Pacific Millennium Packaging Group Corporation (HKG:1820) 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.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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’.
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 Pacific Millennium Packaging Group:
0.16 = CN¥132m ÷ (CN¥1.5b – CN¥696m) (Based on the trailing twelve months to June 2019.)
Therefore, Pacific Millennium Packaging Group has an ROCE of 16%.
Does Pacific Millennium Packaging Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that Pacific Millennium Packaging Group’s ROCE is fairly close to the Packaging industry average of 13%. Regardless of where Pacific Millennium Packaging Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how Pacific Millennium Packaging Group’s ROCE compares to its industry.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Pacific Millennium Packaging Group.
Do Pacific Millennium Packaging Group’s Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Pacific Millennium Packaging Group has total liabilities of CN¥696m and total assets of CN¥1.5b. As a result, its current liabilities are equal to approximately 45% of its total assets. Pacific Millennium Packaging Group has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Pacific Millennium Packaging Group’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. There might be better investments than Pacific Millennium Packaging Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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.