Today we'll evaluate Graphic Packaging Holding Company (NYSE:GPK) to determine whether it could have potential as an investment idea. 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.
First of all, we'll work out how to 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Graphic Packaging Holding:
0.083 = US$490m ÷ (US$7.1b - US$1.2b) (Based on the trailing twelve months to December 2018.)
Therefore, Graphic Packaging Holding has an ROCE of 8.3%.
Does Graphic Packaging Holding Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Graphic Packaging Holding's ROCE appears to be significantly below the 12% average in the Packaging industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Graphic Packaging Holding's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Graphic Packaging Holding's current ROCE of 8.3% is lower than its ROCE in the past, which was 13%, 3 years ago. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and 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 Graphic Packaging Holding.
What Are Current Liabilities, And How Do They Affect Graphic Packaging Holding's 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.
Graphic Packaging Holding has total liabilities of US$1.2b and total assets of US$7.1b. As a result, its current liabilities are equal to approximately 17% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Graphic Packaging Holding's ROCE
That said, Graphic Packaging Holding's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Graphic Packaging Holding. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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.