What Can We Make Of Palace Banquet Holdings Limited’s (HKG:1703) High Return On Capital?

Today we are going to look at Palace Banquet Holdings Limited (HKG:1703) to see whether it might be an attractive investment prospect. 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.

First, 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 measures the 'return' (pre-tax profit) a company generates from 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. 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 Palace Banquet Holdings:

0.085 = HK$53m ÷ (HK$897m - HK$278m) (Based on the trailing twelve months to September 2019.)

So, Palace Banquet Holdings has an ROCE of 8.5%.

View our latest analysis for Palace Banquet Holdings

Is Palace Banquet Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Palace Banquet Holdings's ROCE appears to be substantially greater than the 5.1% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from how Palace Banquet Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

We can see that, Palace Banquet Holdings currently has an ROCE of 8.5%, less than the 44% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Palace Banquet Holdings's ROCE compares to its industry. Click to see more on past growth.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. If Palace Banquet Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Palace Banquet 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 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.

Palace Banquet Holdings has current liabilities of HK$278m and total assets of HK$897m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Palace Banquet Holdings has a medium level of current liabilities, which would boost its ROCE somewhat.

Our Take On Palace Banquet Holdings's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.