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Is There More To Galliford Try plc (LON:GFRD) Than Its 17% Returns On Capital?

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Today we'll look at Galliford Try plc (LON:GFRD) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

So, How Do We Calculate ROCE?

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 Galliford Try:

0.17 = UK£175m ÷ (UK£3.3b - UK£2.3b) (Based on the trailing twelve months to December 2018.)

Therefore, Galliford Try has an ROCE of 17%.

Check out our latest analysis for Galliford Try

Is Galliford Try's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Galliford Try's ROCE is around the 18% average reported by the Construction industry. Independently of how Galliford Try compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Our data shows that Galliford Try currently has an ROCE of 17%, compared to its ROCE of 13% 3 years ago. This makes us wonder if the company is improving.

LSE:GFRD Past Revenue and Net Income, April 9th 2019
LSE:GFRD Past Revenue and Net Income, April 9th 2019

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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Galliford Try.

What Are Current Liabilities, And How Do They Affect Galliford Try's 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Galliford Try has total liabilities of UK£2.3b and total assets of UK£3.3b. As a result, its current liabilities are equal to approximately 69% of its total assets. Galliford Try's current liabilities are fairly high, which increases its ROCE significantly.

Our Take On Galliford Try's ROCE

The ROCE would not look as appealing if the company had fewer current liabilities. You might be able to find a better buy than Galliford Try. 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).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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 editorial-team@simplywallst.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.