Shareholders Should Look Hard At GATX Corporation’s (NYSE:GATX) 4.3% Return On Capital

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Today we’ll look at GATX Corporation (NYSE:GATX) and reflect on its potential as an investment. 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. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is 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. In brief, it is a useful tool, but it is not without drawbacks. 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 GATX:

0.043 = US$313m ÷ (US$7.6b – US$288m) (Based on the trailing twelve months to December 2018.)

Therefore, GATX has an ROCE of 4.3%.

Check out our latest analysis for GATX

Does GATX Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see GATX’s ROCE is meaningfully below the Trade Distributors industry average of 8.0%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how GATX compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. Readers may wish to look for more rewarding investments.

NYSE:GATX Last Perf February 11th 19
NYSE:GATX Last Perf February 11th 19

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for GATX.

What Are Current Liabilities, And How Do They Affect GATX’s 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.

GATX has total liabilities of US$288m and total assets of US$7.6b. As a result, its current liabilities are equal to approximately 3.8% of its total assets. With barely any current liabilities, there is minimal impact on GATX’s admittedly low ROCE.

What We Can Learn From GATX’s ROCE

Nevertheless, there are potentially more attractive companies to invest in. But note: GATX may not be the best stock to buy. 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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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.