Today we are going to look at King’s Flair International (Holdings) Limited (HKG:6822) 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, we’ll go over how we 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.

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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 King’s Flair International (Holdings):

0.24 = HK$156m ÷ (HK$962m – HK$280m) (Based on the trailing twelve months to June 2018.)

Therefore, King’s Flair International (Holdings) has an ROCE of 24%.

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Does King’s Flair International (Holdings) Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, King’s Flair International (Holdings)’s ROCE is meaningfully higher than the 9.9% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, King’s Flair International (Holdings)’s ROCE currently appears to be excellent.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 King’s Flair International (Holdings) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How King’s Flair International (Holdings)’s Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

King’s Flair International (Holdings) has total assets of HK$962m and current liabilities of HK$280m. As a result, its current liabilities are equal to approximately 29% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.

What We Can Learn From King’s Flair International (Holdings)’s ROCE

With low current liabilities and a high ROCE, King’s Flair International (Holdings) could be worthy of further investigation. But note: King’s Flair International (Holdings) may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.