Today we are going to look at GEA Group Aktiengesellschaft (FRA:G1A) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. Ultimately, it is a useful but imperfect metric. 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?
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 GEA Group:
0.068 = €296m ÷ (€6.1b – €2.2b) (Based on the trailing twelve months to September 2018.)
So, GEA Group has an ROCE of 6.8%.
Does GEA Group Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, GEA Group’s ROCE appears meaningfully below the 11% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, GEA Group’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. You can see analyst predictions in our free report on analyst forecasts for the company.
Do GEA Group’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
GEA Group has total assets of €6.1b and current liabilities of €2.2b. As a result, its current liabilities are equal to approximately 37% of its total assets. GEA Group’s middling level of current liabilities have the effect of boosting its ROCE a bit.
What We Can Learn From GEA Group’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. You might be able to find a better buy than GEA Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
Of course GEA Group may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
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 email@example.com.