Should You Be Excited About Gravity's (NASDAQ:GRVY) Returns On Capital?

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Gravity's (NASDAQ:GRVY) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Gravity, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.36 = ₩63b ÷ (₩255b - ₩82b) (Based on the trailing twelve months to September 2020).

So, Gravity has an ROCE of 36%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

Check out our latest analysis for Gravity

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Gravity, check out these free graphs here.

The Trend Of ROCE

The fact that Gravity is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 36% which is a sight for sore eyes. In addition to that, Gravity is employing 274% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 32% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line

In summary, it's great to see that Gravity has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 10,865% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.

If you'd like to know about the risks facing Gravity, we've discovered 1 warning sign that you should be aware of.

Gravity is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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. 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. Simply Wall St has no position in any stocks mentioned.
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