Today we are going to look at Emperor Watch & Jewellery Limited (HKG:887) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
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. 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 Emperor Watch & Jewellery:
0.055 = HK$310m ÷ (HK$6.7b - HK$1.1b) (Based on the trailing twelve months to June 2019.)
Therefore, Emperor Watch & Jewellery has an ROCE of 5.5%.
Does Emperor Watch & Jewellery Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Emperor Watch & Jewellery's ROCE appears to be significantly below the 12% average in the Specialty Retail industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Emperor Watch & Jewellery stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
Emperor Watch & Jewellery delivered an ROCE of 5.5%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can see in the image below how Emperor Watch & Jewellery's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Emperor Watch & Jewellery is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Emperor Watch & Jewellery's Current Liabilities Skew Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Emperor Watch & Jewellery has total assets of HK$6.7b and current liabilities of HK$1.1b. As a result, its current liabilities are equal to approximately 17% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Emperor Watch & Jewellery's ROCE
With that in mind, we're not overly impressed with Emperor Watch & Jewellery's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Emperor Watch & Jewellery. 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 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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