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What Can We Make Of Carlo Gavazzi Holding AG’s (VTX:GAV) High Return On Capital?

Simply Wall St

Today we are going to look at Carlo Gavazzi Holding AG (VTX:GAV) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

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 Carlo Gavazzi Holding:

0.14 = CHF15m ÷ (CHF136m - CHF29m) (Based on the trailing twelve months to March 2019.)

So, Carlo Gavazzi Holding has an ROCE of 14%.

View our latest analysis for Carlo Gavazzi Holding

Is Carlo Gavazzi Holding's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that Carlo Gavazzi Holding's ROCE is meaningfully better than the 11% average in the Electrical industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Carlo Gavazzi Holding sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can click on the image below to see (in greater detail) how Carlo Gavazzi Holding's past growth compares to other companies.

SWX:GAV Past Revenue and Net Income, September 22nd 2019

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Carlo Gavazzi Holding.

Do Carlo Gavazzi Holding's Current Liabilities Skew Its 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Carlo Gavazzi Holding has total assets of CHF136m and current liabilities of CHF29m. As a result, its current liabilities are equal to approximately 21% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On Carlo Gavazzi Holding's ROCE

Overall, Carlo Gavazzi Holding has a decent ROCE and could be worthy of further research. Carlo Gavazzi Holding 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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 editorial-team@simplywallst.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.