Today we'll evaluate The Go-Ahead Group plc (LON:GOG) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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.
So, How Do We Calculate ROCE?
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 Go-Ahead Group:
0.14 = UK£122m ÷ (UK£1.8b - UK£904m) (Based on the trailing twelve months to June 2019.)
So, Go-Ahead Group has an ROCE of 14%.
Is Go-Ahead Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Go-Ahead Group's ROCE appears to be around the 13% average of the Transportation industry. Regardless of where Go-Ahead Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Go-Ahead Group's current ROCE of 14% is lower than 3 years ago, when the company reported a 25% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Go-Ahead Group's ROCE compares to its industry. Click to see more on past growth.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Go-Ahead Group.
Do Go-Ahead Group's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Go-Ahead Group has total assets of UK£1.8b and current liabilities of UK£904m. Therefore its current liabilities are equivalent to approximately 50% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
The Bottom Line On Go-Ahead Group's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Go-Ahead Group 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.
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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.