Today we'll look at Okura Holdings Limited (HKG:1655) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Okura Holdings:
0.04 = JP¥1.1b ÷ (JP¥29b - JP¥3.1b) (Based on the trailing twelve months to December 2019.)
So, Okura Holdings has an ROCE of 4.0%.
Does Okura Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Okura Holdings's ROCE appears to be significantly below the 5.5% average in the Hospitality industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Okura Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Okura Holdings's current ROCE of 4.0% is lower than its ROCE in the past, which was 7.1%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Okura 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 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. How cyclical is Okura Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Okura Holdings's Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Okura Holdings has current liabilities of JP¥3.1b and total assets of JP¥29b. As a result, its current liabilities are equal to approximately 11% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Okura Holdings's ROCE
While that is good to see, Okura Holdings has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 email@example.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.
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