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Today we are going to look at GBST Holdings Limited (ASX:GBT) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 GBST Holdings:
0.10 = AU$7.7m ÷ (AU$102m – AU$27m) (Based on the trailing twelve months to June 2018.)
So, GBST Holdings has an ROCE of 10%.
Is GBST Holdings’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see GBST Holdings’s ROCE is around the 11% average reported by the IT industry. Separate from how GBST Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
GBST Holdings’s current ROCE of 10% is lower than 3 years ago, when the company reported a 23% ROCE. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for GBST Holdings.
What Are Current Liabilities, And How Do They Affect GBST Holdings’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.
GBST Holdings has total assets of AU$102m and current liabilities of AU$27m. As a result, its current liabilities are equal to approximately 27% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
Our Take On GBST Holdings’s ROCE
If GBST Holdings continues to earn an uninspiring ROCE, there may be better places to invest. Of course you might be able to find a better stock than GBST Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.