Luk Fook Holdings (International) Limited (HKG:590) Is Employing Capital Very Effectively

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Today we’ll look at Luk Fook Holdings (International) Limited (HKG:590) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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’.

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 Luk Fook Holdings (International):

0.18 = HK\$1.6b ÷ (HK\$13b – HK\$3.4b) (Based on the trailing twelve months to September 2018.)

Therefore, Luk Fook Holdings (International) has an ROCE of 18%.

Is Luk Fook Holdings (International)’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Luk Fook Holdings (International)’s ROCE is meaningfully higher than the 13% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Luk Fook Holdings (International) compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Luk Fook Holdings (International).

How Luk Fook Holdings (International)’s Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Luk Fook Holdings (International) has total assets of HK\$13b and current liabilities of HK\$3.4b. As a result, its current liabilities are equal to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Luk Fook Holdings (International)’s ROCE

With that in mind, Luk Fook Holdings (International)’s ROCE appears pretty good. But note: Luk Fook Holdings (International) 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).

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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.