Today we are going to look at General Finance Corporation (NASDAQ:GFN) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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.
Understanding Return On Capital Employed (ROCE)
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. 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 General Finance:
0.082 = US$60m ÷ (US$794m - US$59m) (Based on the trailing twelve months to December 2019.)
So, General Finance has an ROCE of 8.2%.
Is General Finance's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, General Finance's ROCE appears to be around the 9.4% average of the Trade Distributors industry. Aside from the industry comparison, General Finance's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
We can see that, General Finance currently has an ROCE of 8.2% compared to its ROCE 3 years ago, which was 3.7%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how General Finance's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for General Finance.
General Finance's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
General Finance has total assets of US$794m and current liabilities of US$59m. Therefore its current liabilities are equivalent to approximately 7.4% of its total assets. General Finance has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On General Finance's ROCE
General Finance looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than General Finance. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like General Finance better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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