Today we'll look at Good Spirits Hospitality Limited (NZSE:GSH) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Good Spirits Hospitality:
0.13 = NZ$4.7m ÷ (NZ$41m - NZ$4.1m) (Based on the trailing twelve months to June 2019.)
So, Good Spirits Hospitality has an ROCE of 13%.
Does Good Spirits Hospitality Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Good Spirits Hospitality's ROCE is meaningfully better than the 9.8% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Good Spirits Hospitality compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Good Spirits Hospitality's current ROCE of 13% is lower than 3 years ago, when the company reported a 25% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Good Spirits Hospitality's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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. You can check if Good Spirits Hospitality has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Good Spirits Hospitality'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.
Good Spirits Hospitality has total liabilities of NZ$4.1m and total assets of NZ$41m. As a result, its current liabilities are equal to approximately 10% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Good Spirits Hospitality's ROCE
This is good to see, and with a sound ROCE, Good Spirits Hospitality could be worth a closer look. Good Spirits Hospitality shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Good Spirits Hospitality better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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