Today we’ll look at Gunnebo AB (publ) (STO:GUNN) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its 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’.
How Do You Calculate Return On Capital Employed?
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 Gunnebo:
0.075 = kr252m ÷ (kr4.9b – kr1.5b) (Based on the trailing twelve months to December 2018.)
Therefore, Gunnebo has an ROCE of 7.5%.
Is Gunnebo’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Gunnebo’s ROCE is fairly close to the Commercial Services industry average of 7.9%. Setting aside the industry comparison for now, Gunnebo’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Gunnebo’s current ROCE of 7.5% is lower than 3 years ago, when the company reported a 12% 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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Gunnebo’s Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Gunnebo has total assets of kr4.9b and current liabilities of kr1.5b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Gunnebo has a medium level of current liabilities, which would boost its ROCE somewhat.
What We Can Learn From Gunnebo’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than Gunnebo. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Gunnebo better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.