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Go-Ahead Group (LON:GOG) May Have Issues Allocating Its Capital

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·3 min read
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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Go-Ahead Group (LON:GOG), it didn't seem to tick all of these boxes.

Understanding 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. Analysts use this formula to calculate it for Go-Ahead Group:

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

0.056 = UK£47m ÷ (UK£2.0b - UK£1.2b) (Based on the trailing twelve months to January 2021).

Thus, Go-Ahead Group has an ROCE of 5.6%. In absolute terms, that's a low return, but it's much better than the Transportation industry average of 3.0%.

See our latest analysis for Go-Ahead Group

roce
roce

In the above chart we have measured Go-Ahead Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Go-Ahead Group here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Go-Ahead Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.6% from 23% five years ago. However it looks like Go-Ahead Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, Go-Ahead Group has a high ratio of current liabilities to total assets of 58%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Go-Ahead Group's ROCE

In summary, Go-Ahead Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 65% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Go-Ahead Group has the makings of a multi-bagger.

On a final note, we've found 1 warning sign for Go-Ahead Group that we think you should be aware of.

While Go-Ahead Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.