Today we’ll look at Coreana Cosmetics Co.,Ltd. (KOSDAQ:027050) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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.
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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Coreana CosmeticsLtd:
0.037 = ₩3.6b ÷ (₩119b – ₩22b) (Based on the trailing twelve months to September 2019.)
So, Coreana CosmeticsLtd has an ROCE of 3.7%.
Is Coreana CosmeticsLtd’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Coreana CosmeticsLtd’s ROCE appears meaningfully below the 8.4% average reported by the Personal Products industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Coreana CosmeticsLtd compares to its industry, its ROCE in absolute terms is low; especially compared to the ~3.4% available in government bonds. There are potentially more appealing investments elsewhere.
The image below shows how Coreana CosmeticsLtd’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. If Coreana CosmeticsLtd is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Coreana CosmeticsLtd’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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Coreana CosmeticsLtd has current liabilities of ₩22b and total assets of ₩119b. As a result, its current liabilities are equal to approximately 18% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From Coreana CosmeticsLtd’s ROCE
While that is good to see, Coreana CosmeticsLtd has a low ROCE and does not look attractive in this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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