Hongkong Land Holdings Limited (SGX: H78) is a real estate investor and developer. Its main business involves an investment portfolio of prime commercial properties that are located in the Central area of Hong Kong.
At the current price of US$6.89, Hongkong Land’s stock is just 2.5% higher than a 52-week low of US$6.72. This captured my attention and got me interested in finding out more about the company. In particular, I want to understand: Does it have a high quality business?
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This question is important. If Hongkong Land has a high quality business, its current low stock price could be an investment opportunity. Unfortunately, there’s no easy answer to the question. But, a simple metric can help shed some light on the question: The return on invested capital (ROIC).
A brief introduction to the ROIC
In a previous article of mine, I explained how the ROIC can be used to evaluate the quality of a business.
The simple idea behind the ROIC is that a business with a higher ROIC requires less capital to generate a profit, and it thus gives investors a higher return per dollar that is invested in the business. High-quality businesses tend to have high ROICs while the reverse is true – a low ROIC is often associated with a low-quality business.
You can see how the math works for the ROIC in the formula above.
Hongkong Land’s ROIC
Here’s a table showing how Hongkong Land’s ROIC looks like (I had used numbers from its fiscal year ended 31 December 2017):
Source: Hongkong Land earnings update
In 2017, Hongkong Land generated a ROIC of 16.5%. This means that for every dollar of capital invested in the business, Hongkong Land earned 16.5 cents in profit. The company’s ROIC of 16.5% is slightly above average, based on the ROICs of many other companies I have studied in the past. This suggests that Hongkong Land has a quality business.
But, there’s one important point that investors should know about Hongkong Land when using the ROIC figure calculated above. My figure for profit before interest and tax of US$5,588.5 million includes a fair value gain from its investment properties of about US$4,677.9 million. Given that the gain is unrealised and irregular in nature, it might be useful for investors to adjust for the fair value gain to calculate an adjusted ROIC to better reflect the recurring part of the company’s earnings. After adjusting for Hongkong Land’s US$4,677.9 million in fair value gain, the company’s ROIC becomes 3% instead.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned. The Motley Fool Singapore has a recommendation for Hongkong Land.