Why Yau Lee Holdings Limited’s (HKG:406) Use Of Investor Capital Doesn’t Look Great

Today we'll evaluate Yau Lee Holdings Limited (HKG:406) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.

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 Yau Lee Holdings:

0.021 = HK$61m ÷ (HK$5.1b - HK$2.2b) (Based on the trailing twelve months to September 2019.)

Therefore, Yau Lee Holdings has an ROCE of 2.1%.

View our latest analysis for Yau Lee Holdings

Does Yau Lee Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Yau Lee Holdings's ROCE is meaningfully below the Construction industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Yau Lee 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.

Yau Lee Holdings has an ROCE of 2.1%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Yau Lee Holdings's past growth compares to other companies.

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. You can check if Yau Lee Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Yau Lee 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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Yau Lee Holdings has total liabilities of HK$2.2b and total assets of HK$5.1b. Therefore its current liabilities are equivalent to approximately 44% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Yau Lee Holdings's low ROCE is unappealing.

What We Can Learn From Yau Lee Holdings's ROCE

So researching other companies may be a better use of your time. 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.

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.