Here’s why Gévelot SA’s (EPA:ALGEV) Returns On Capital Matters So Much

Today we’ll look at Gévelot SA (EPA:ALGEV) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. 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?

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 Gévelot:

0.042 = €8.7m ÷ (€291m – €82m) (Based on the trailing twelve months to June 2019.)

Therefore, Gévelot has an ROCE of 4.2%.

View our latest analysis for Gévelot

Does Gévelot Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Gévelot’s ROCE appears meaningfully below the 8.7% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Gévelot 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.

The image below shows how Gévelot’s ROCE compares to its industry, and you can click it to see more detail on its past growth.

ENXTPA:ALGEV Past Revenue and Net Income March 26th 2020
ENXTPA:ALGEV Past Revenue and Net Income March 26th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. How cyclical is Gévelot? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Gévelot’s 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Gévelot has total assets of €291m and current liabilities of €82m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From Gévelot’s ROCE

That said, Gévelot’s ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Gévelot. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Gévelot better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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