Today we’ll look at Geke S.A. (ATH:PRESD) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
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 Geke:
0.057 = €3.6m ÷ (€66m – €2.6m) (Based on the trailing twelve months to June 2018.)
Therefore, Geke has an ROCE of 5.7%.
Is Geke’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Geke’s ROCE is meaningfully below the Hospitality industry average of 8.3%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Geke stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Our data shows that Geke currently has an ROCE of 5.7%, compared to its ROCE of 3.5% 3 years ago. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. If Geke is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Geke’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Geke has total assets of €66m and current liabilities of €2.6m. Therefore its current liabilities are equivalent to approximately 3.9% of its total assets. With barely any current liabilities, there is minimal impact on Geke’s admittedly low ROCE.
What We Can Learn From Geke’s ROCE
Nonetheless, there may be better places to invest your capital. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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If you spot an error that warrants correction, please contact the editor at email@example.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.