Are TK Group (Holdings) Limited’s (HKG:2283) High Returns Really That Great?

Today we are going to look at TK Group (Holdings) Limited (HKG:2283) 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.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?

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 TK Group (Holdings):

0.23 = HK$374m ÷ (HK$2.5b - HK$842m) (Based on the trailing twelve months to June 2019.)

So, TK Group (Holdings) has an ROCE of 23%.

See our latest analysis for TK Group (Holdings)

Does TK Group (Holdings) Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that TK Group (Holdings)'s ROCE is meaningfully better than the 9.9% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, TK Group (Holdings)'s ROCE in absolute terms currently looks quite high.

We can see that, TK Group (Holdings) currently has an ROCE of 23%, less than the 31% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how TK Group (Holdings)'s ROCE compares to its industry. Click to see more on past growth.

SEHK:2283 Past Revenue and Net Income, September 20th 2019
SEHK:2283 Past Revenue and Net Income, September 20th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for TK Group (Holdings).

What Are Current Liabilities, And How Do They Affect TK Group (Holdings)'s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

TK Group (Holdings) has total assets of HK$2.5b and current liabilities of HK$842m. Therefore its current liabilities are equivalent to approximately 34% of its total assets. TK Group (Holdings)'s ROCE is boosted somewhat by its middling amount of current liabilities.

Our Take On TK Group (Holdings)'s ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. There might be better investments than TK Group (Holdings) out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.