Why You Should Care About Gévelot SA’s (EPA:ALGEV) Low Return On Capital

Today we’ll evaluate Gévelot SA (EPA:ALGEV) to determine whether it could have potential as an investment idea. 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. 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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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’.

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 Gévelot:

0.036 = €7.4m ÷ (€281m – €77m) (Based on the trailing twelve months to December 2018.)

Therefore, Gévelot has an ROCE of 3.6%.

Check out our latest analysis for Gévelot

Does Gévelot Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Gévelot’s ROCE is meaningfully below the Machinery industry average of 11%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Gévelot’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

ENXTPA:ALGEV Past Revenue and Net Income, July 23rd 2019
ENXTPA:ALGEV Past Revenue and Net Income, July 23rd 2019

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. How cyclical is Gévelot? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Gévelot’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Gévelot has total liabilities of €77m and total assets of €281m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

What We Can Learn From Gévelot’s ROCE

That’s not a bad thing, however Gévelot has a weak ROCE and may not be an attractive investment. 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.

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

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.

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. Thank you for reading.