Today we’ll evaluate Shuang Yun Holdings Limited (HKG:1706) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.’

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 Shuang Yun Holdings:

0.13 = S$8.4m ÷ (S$97m – S$38m) (Based on the trailing twelve months to June 2018.)

Therefore, Shuang Yun Holdings has an ROCE of 13%.

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Is Shuang Yun Holdings’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Shuang Yun Holdings’s ROCE appears to be around the 14% average of the Construction industry. Regardless of where Shuang Yun Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

As we can see, Shuang Yun Holdings currently has an ROCE of 13%, less than the 34% it reported 3 years ago. So investors might consider if it has had issues recently.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. If Shuang Yun Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Shuang Yun Holdings’s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.

Shuang Yun Holdings has total liabilities of S$38m and total assets of S$97m. Therefore its current liabilities are equivalent to approximately 40% of its total assets. Shuang Yun Holdings has a medium level of current liabilities, which would boost the ROCE.

Our Take On Shuang Yun Holdings’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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 editorial-team@simplywallst.com.