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Today we are going to look at Gravity Co., Ltd. (NASDAQ:GRVY) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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 Gravity:
0.52 = ₩53b ÷ (₩198b – ₩97b) (Based on the trailing twelve months to March 2019.)
Therefore, Gravity has an ROCE of 52%.
Is Gravity’s ROCE Good?
One way to assess ROCE is to compare similar companies. Gravity’s ROCE appears to be substantially greater than the 9.1% average in the Entertainment industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Gravity’s ROCE currently appears to be excellent.
Gravity reported an ROCE of 52% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been 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 Gravity is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Gravity’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Gravity has total liabilities of ₩97b and total assets of ₩198b. As a result, its current liabilities are equal to approximately 49% of its total assets. Gravity has a medium level of current liabilities, boosting its ROCE somewhat.
Our Take On Gravity’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Gravity looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.