Why We Like GR Engineering Services Limited’s (ASX:GNG) 18% Return On Capital Employed

Today we'll evaluate GR Engineering Services Limited (ASX:GNG) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we 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.

What is 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. In general, businesses with a higher ROCE are usually better quality. 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?

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 GR Engineering Services:

0.18 = AU$9.0m ÷ (AU$84m - AU$34m) (Based on the trailing twelve months to December 2018.)

Therefore, GR Engineering Services has an ROCE of 18%.

See our latest analysis for GR Engineering Services

Does GR Engineering Services Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, GR Engineering Services's ROCE is meaningfully higher than the 8.3% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where GR Engineering Services sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

GR Engineering Services's current ROCE of 18% is lower than its ROCE in the past, which was 32%, 3 years ago. Therefore we wonder if the company is facing new headwinds.

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 only a point-in-time measure. Given the industry it operates in, GR Engineering Services could be considered cyclical. Since the future is so important for investors, you should check out our freereport on analyst forecasts for GR Engineering Services.

How GR Engineering Services's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

GR Engineering Services has total assets of AU$84m and current liabilities of AU$34m. Therefore its current liabilities are equivalent to approximately 40% of its total assets. GR Engineering Services has a middling amount of current liabilities, increasing its ROCE somewhat.

What We Can Learn From GR Engineering Services's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this freelist of companies with modest (or no) debt, trading on a P/E below 20.

If you are like me, then you will not want to miss this freelist of growing companies that insiders are buying.

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.