Today we’ll evaluate HK Electric Investments and HK Electric Investments Limited (HKG:2638) 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. And finally, we’ll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. In brief, ROCE is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 HK Electric Investments and HK Electric Investments:
0.051 = HK$5.3b ÷ (HK$109b – HK$5.3b) (Based on the trailing twelve months to June 2018.)
So, HK Electric Investments and HK Electric Investments has an ROCE of 5.1%.
Is HK Electric Investments and HK Electric Investments’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that HK Electric Investments and HK Electric Investments’s ROCE is fairly close to the Electric Utilities industry average of 5.1%. Putting aside HK Electric Investments and HK Electric Investments’s performance relative to its industry, its ROCE in absolute terms is poor – not much better than government bonds. Readers may wish to look for more rewarding investments.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for HK Electric Investments and HK Electric Investments.
What Are Current Liabilities, And How Do They Affect HK Electric Investments and HK Electric Investments’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
HK Electric Investments and HK Electric Investments has total assets of HK$109b and current liabilities of HK$5.3b. As a result, its current liabilities are equal to approximately 4.8% of its total assets.
What We Can Learn From HK Electric Investments and HK Electric Investments’s ROCE
HK Electric Investments and HK Electric Investments has very few current liabilities, which have a minimal effect on its already low ROCE. Nevertheless, there are potentially more attractive companies to invest in. Of course you might be able to find a better stock than HK Electric Investments and HK Electric Investments. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.
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.