Today we'll evaluate Citychamp Watch & Jewellery Group Limited (HKG:256) 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.
First, 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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.
So, How Do We Calculate ROCE?
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 Citychamp Watch & Jewellery Group:
0.017 = HK$302m ÷ (HK$20b - HK$2.2b) (Based on the trailing twelve months to June 2019.)
Therefore, Citychamp Watch & Jewellery Group has an ROCE of 1.7%.
Does Citychamp Watch & Jewellery Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Citychamp Watch & Jewellery Group's ROCE appears meaningfully below the 9.6% average reported by the Luxury industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Citychamp Watch & Jewellery Group stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Citychamp Watch & Jewellery Group's current ROCE of 1.7% is lower than 3 years ago, when the company reported a 4.0% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Citychamp Watch & Jewellery Group's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Citychamp Watch & Jewellery Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Citychamp Watch & Jewellery Group'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Citychamp Watch & Jewellery Group has total assets of HK$20b and current liabilities of HK$2.2b. As a result, its current liabilities are equal to approximately 11% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Citychamp Watch & Jewellery Group's ROCE
That's not a bad thing, however Citychamp Watch & Jewellery Group has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Citychamp Watch & Jewellery Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.
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. Thank you for reading.