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Don’t Buy W. R. Grace & Co. (NYSE:GRA) Until You Understand Its ROCE

Simply Wall St

Today we are going to look at W. R. Grace & Co. (NYSE:GRA) 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.

First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. 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.’

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 W. R. Grace:

0.12 = US$360m ÷ (US$3.6b – US$514m) (Based on the trailing twelve months to December 2018.)

So, W. R. Grace has an ROCE of 12%.

View our latest analysis for W. R. Grace

Does W. R. Grace Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, W. R. Grace’s ROCE appears to be around the 12% average of the Chemicals industry. Regardless of where W. R. Grace sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

NYSE:GRA Past Revenue and Net Income, March 17th 2019

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. 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.

What Are Current Liabilities, And How Do They Affect W. R. Grace’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.

W. R. Grace has total assets of US$3.6b and current liabilities of US$514m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From W. R. Grace’s ROCE

This is good to see, and with a sound ROCE, W. R. Grace could be worth a closer look. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.