Today we'll evaluate Town Ray Holdings Limited (HKG:1692) to determine whether it could have potential as an investment idea. 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. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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.
So, How Do We Calculate ROCE?
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 Town Ray Holdings:
0.25 = HK$39m ÷ (HK$270m - HK$115m) (Based on the trailing twelve months to December 2018.)
So, Town Ray Holdings has an ROCE of 25%.
Is Town Ray Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Town Ray Holdings's ROCE is meaningfully higher than the 10% average in the Consumer Durables 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, Town Ray Holdings's ROCE in absolute terms currently looks quite high.
You can click on the image below to see (in greater detail) how Town Ray 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 only a point-in-time measure. How cyclical is Town Ray Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Town Ray Holdings's Current Liabilities And Their Impact On 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Town Ray Holdings has total assets of HK$270m and current liabilities of HK$115m. As a result, its current liabilities are equal to approximately 42% of its total assets. Town Ray Holdings has a medium level of current liabilities, boosting its ROCE somewhat.
The Bottom Line On Town Ray Holdings's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Town Ray Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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.
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.