Here's What Chi Ho Development Holdings Limited's (HKG:8423) ROCE Can Tell Us
Today we are going to look at Chi Ho Development Holdings Limited (HKG:8423) 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 of all, we'll work out how to calculate ROCE. 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Chi Ho Development Holdings:
0.31 = HK$31m ÷ (HK$297m - HK$195m) (Based on the trailing twelve months to September 2019.)
So, Chi Ho Development Holdings has an ROCE of 31%.
Check out our latest analysis for Chi Ho Development Holdings
Does Chi Ho Development Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Chi Ho Development Holdings's ROCE appears to be substantially greater than the 12% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Chi Ho Development Holdings's ROCE in absolute terms currently looks quite high.
Chi Ho Development Holdings's current ROCE of 31% is lower than its ROCE in the past, which was 56%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Chi Ho Development Holdings'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. If Chi Ho Development Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Chi Ho Development Holdings'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.
Chi Ho Development Holdings has total liabilities of HK$195m and total assets of HK$297m. As a result, its current liabilities are equal to approximately 66% of its total assets. While a high level of current liabilities boosts its ROCE, Chi Ho Development Holdings's returns are still very good.
Our Take On Chi Ho Development Holdings's ROCE
In my book, this business could be worthy of further research. Chi Ho Development Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
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.
