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Today we are going to look at Gresham Technologies plc (LON:GHT) 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. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the 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. 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 Gresham Technologies:
0.053 = UK£3.1m ÷ (UK£34m – UK£8.6m) (Based on the trailing twelve months to June 2018.)
Therefore, Gresham Technologies has an ROCE of 5.3%.
Does Gresham Technologies Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Gresham Technologies’s ROCE appears to be significantly below the 12% average in the Software industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Gresham Technologies’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
In our analysis, Gresham Technologies’s ROCE appears to be 5.3%, compared to 3 years ago, when its ROCE was 4.2%. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Gresham Technologies.
How Gresham Technologies’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Gresham Technologies has total liabilities of UK£8.6m and total assets of UK£34m. As a result, its current liabilities are equal to approximately 25% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On Gresham Technologies’s ROCE
With that in mind, we’re not overly impressed with Gresham Technologies’s ROCE, so it may not be the most appealing prospect. You might be able to find a better buy than Gresham Technologies. 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).
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.