Today we'll evaluate Greif, Inc. (NYSE:GEF) 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.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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'.
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 Greif:
0.093 = US$437m ÷ (US$5.6b - US$837m) (Based on the trailing twelve months to July 2019.)
So, Greif has an ROCE of 9.3%.
Does Greif Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Greif's ROCE is around the 10% average reported by the Packaging industry. Separate from how Greif stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
We can see that, Greif currently has an ROCE of 9.3%, less than the 13% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Greif's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. 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 Greif's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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.
Greif has total liabilities of US$837m and total assets of US$5.6b. As a result, its current liabilities are equal to approximately 15% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On Greif's ROCE
With that in mind, we're not overly impressed with Greif's ROCE, so it may not be the most appealing prospect. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 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.