Today we are going to look at Grand Canyon Education, Inc. (NASDAQ:LOPE) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. 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 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?
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 Grand Canyon Education:
0.16 = US$253m ÷ (US$1.7b - US$113m) (Based on the trailing twelve months to June 2019.)
Therefore, Grand Canyon Education has an ROCE of 16%.
Does Grand Canyon Education Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Grand Canyon Education's ROCE appears to be substantially greater than the 9.4% average in the Consumer Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Grand Canyon Education's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Grand Canyon Education's current ROCE of 16% is lower than its ROCE in the past, which was 29%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Grand Canyon Education's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 Grand Canyon Education.
How Grand Canyon Education's Current Liabilities Impact 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Grand Canyon Education has total assets of US$1.7b and current liabilities of US$113m. Therefore its current liabilities are equivalent to approximately 6.8% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Grand Canyon Education earns a sound return on capital employed.
Our Take On Grand Canyon Education's ROCE
If it is able to keep this up, Grand Canyon Education could be attractive. Grand Canyon Education 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.