Today we'll evaluate Hock Lian Seng Holdings Limited (SGX:J2T) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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. In general, businesses with a higher ROCE are usually better quality. 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.
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 Hock Lian Seng Holdings:
0.075 = S$16m ÷ (S$324m - S$115m) (Based on the trailing twelve months to December 2019.)
So, Hock Lian Seng Holdings has an ROCE of 7.5%.
Does Hock Lian Seng Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Hock Lian Seng Holdings's ROCE appears to be substantially greater than the 3.1% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how Hock Lian Seng Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
The image below shows how Hock Lian Seng Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Hock Lian Seng Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Hock Lian Seng 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Hock Lian Seng Holdings has current liabilities of S$115m and total assets of S$324m. As a result, its current liabilities are equal to approximately 36% of its total assets. Hock Lian Seng Holdings's ROCE is improved somewhat by its moderate amount of current liabilities.
What We Can Learn From Hock Lian Seng Holdings's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than Hock Lian Seng Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.