Today we are going to look at NWS Holdings Limited (HKG:659) 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. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. Ultimately, it is a useful but imperfect metric. 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?
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 NWS Holdings:
0.025 = HK$1.8b ÷ (HK$86b - HK$14b) (Based on the trailing twelve months to June 2019.)
Therefore, NWS Holdings has an ROCE of 2.5%.
Is NWS Holdings's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see NWS Holdings's ROCE is meaningfully below the Industrials industry average of 3.3%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how NWS Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. It is likely that there are more attractive prospects out there.
NWS Holdings's current ROCE of 2.5% is lower than 3 years ago, when the company reported a 4.2% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how NWS Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for NWS Holdings.
How NWS 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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
NWS Holdings has total assets of HK$86b and current liabilities of HK$14b. As a result, its current liabilities are equal to approximately 16% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From NWS Holdings's ROCE
NWS Holdings has a poor ROCE, and there may be better investment prospects out there. 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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