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Don’t Buy Gama Aviation Plc (LON:GMAA) Until You Understand Its ROCE

Simply Wall St

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Today we'll look at Gama Aviation Plc (LON:GMAA) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?

The formula for calculating the return on capital employed is:

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

Or for Gama Aviation:

0.13 = US$11m ÷ (US$151m - US$66m) (Based on the trailing twelve months to December 2018.)

Therefore, Gama Aviation has an ROCE of 13%.

See our latest analysis for Gama Aviation

Does Gama Aviation Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Gama Aviation's ROCE appears to be around the 15% average of the Airlines industry. Independently of how Gama Aviation compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

AIM:GMAA Past Revenue and Net Income, June 17th 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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Gama Aviation's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Gama Aviation has total liabilities of US$66m and total assets of US$151m. Therefore its current liabilities are equivalent to approximately 44% of its total assets. Gama Aviation has a medium level of current liabilities, which would boost the ROCE.

Our Take On Gama Aviation's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Gama Aviation 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.