Here’s why GVC Holdings PLC’s (LON:GVC) Returns On Capital Matters So Much

Today we'll look at GVC Holdings PLC (LON:GVC) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?

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 GVC Holdings:

0.015 = UK£63m ÷ (UK£7.6b - UK£1.0b) (Based on the trailing twelve months to June 2018.)

So, GVC Holdings has an ROCE of 1.5%.

Check out our latest analysis for GVC Holdings

Does GVC Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, GVC Holdings's ROCE appears meaningfully below the 8.6% average reported by the Hospitality industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how GVC Holdings compares to its industry, its ROCE in absolute terms is low; not much better than the ~1.4% available in government bonds. It is likely that there are more attractive prospects out there.

GVC Holdings's current ROCE of 1.5% is lower than 3 years ago, when the company reported a 32% ROCE. 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our freereport on analyst forecasts for GVC Holdings.

GVC Holdings's Current Liabilities And Their Impact On Its 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

GVC Holdings has total assets of UK£7.6b and current liabilities of UK£1.0b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

The Bottom Line On GVC Holdings's ROCE

That's not a bad thing, however GVC Holdings has a weak ROCE and may not be an attractive investment. We prefer high ROCE ratios over lower ones, but a weaker business can also be rewarding if it has managers with skin in the game. Therefore, you will not want to miss this freechart depicting insider transactions

If you would prefer check out another company -- one with potentially superior financials -- then do not miss thisfree list of interesting companies, that have HIGH return on equity 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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.