Today we are going to look at Vedan International (Holdings) Limited (HKG:2317) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. 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 Vedan International (Holdings):
0.064 = US$20m ÷ (US$369m - US$59m) (Based on the trailing twelve months to December 2019.)
Therefore, Vedan International (Holdings) has an ROCE of 6.4%.
Is Vedan International (Holdings)'s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Vedan International (Holdings)'s ROCE appears meaningfully below the 11% average reported by the Food industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Vedan International (Holdings) stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
We can see that, Vedan International (Holdings) currently has an ROCE of 6.4%, less than the 11% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Vedan International (Holdings)'s ROCE compares to its industry. Click to see more on 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. ROCE is only a point-in-time measure. If Vedan International (Holdings) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Vedan International (Holdings)'s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Vedan International (Holdings) has current liabilities of US$59m and total assets of US$369m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On Vedan International (Holdings)'s ROCE
If Vedan International (Holdings) continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Vedan International (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.
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