Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. And in light of that, the trends we're seeing at Gravity's (NASDAQ:GRVY) look very promising so lets take a look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Gravity:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.27 = ₩39b ÷ (₩210b - ₩66b) (Based on the trailing twelve months to June 2020).
Thus, Gravity has an ROCE of 27%. In absolute terms that's a great return and it's even better than the Entertainment industry average of 15%.
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.
How Are Returns Trending?
We're delighted to see that Gravity is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 27% which is a sight for sore eyes. Not only that, but the company is utilizing 199% more capital than before, but that's to be expected from a company 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. Effectively this means that suppliers or short-term creditors are now funding 31% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
What We Can Learn From Gravity's ROCE
In summary, it's great to see that Gravity has managed to break into profitability and is continuing to reinvest in its business. And with the stock having performed exceptionally well over the last five years, these trends are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Gravity can keep these trends up, it could have a bright future ahead.
Gravity does have some risks though, and we've spotted 1 warning sign for Gravity that you might be interested in.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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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