Here’s why Suga International Holdings Limited’s (HKG:912) Returns On Capital Matters So Much

Today we'll evaluate Suga International Holdings Limited (HKG:912) 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.

Understanding 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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'.

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 Suga International Holdings:

0.07 = HK$51m ÷ (HK$1.2b - HK$425m) (Based on the trailing twelve months to September 2019.)

Therefore, Suga International Holdings has an ROCE of 7.0%.

Check out our latest analysis for Suga International Holdings

Does Suga International Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Suga International Holdings's ROCE appears meaningfully below the 10% average reported by the Consumer Durables industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Suga International Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

We can see that, Suga International Holdings currently has an ROCE of 7.0%, less than the 12% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Suga International Holdings's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Suga International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Suga International Holdings's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Suga International Holdings has total assets of HK$1.2b and current liabilities of HK$425m. Therefore its current liabilities are equivalent to approximately 37% of its total assets. Suga International Holdings's middling level of current liabilities have the effect of boosting its ROCE a bit.

The Bottom Line On Suga International 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.