Today we’ll look at G.A. Holdings Limited (HKG:8126) and reflect on its potential as an investment. 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. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is 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’.
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 G.A. Holdings:
0.12 = HK$73m ÷ (HK$1.6b – HK$933m) (Based on the trailing twelve months to December 2018.)
Therefore, G.A. Holdings has an ROCE of 12%.
Is G.A. Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that G.A. Holdings’s ROCE is meaningfully better than the 5.8% average in the Retail Distributors industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how G.A. Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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 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. How cyclical is G.A. Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect G.A. Holdings’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
G.A. Holdings has total assets of HK$1.6b and current liabilities of HK$933m. Therefore its current liabilities are equivalent to approximately 60% of its total assets. G.A. Holdings’s current liabilities are fairly high, which increases its ROCE significantly.
Our Take On G.A. Holdings’s ROCE
While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. You might be able to find a better buy than G.A. Holdings. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 email@example.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.