Today we'll look at G. K. Goh Holdings Limited (SGX:G41) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 G. K. Goh Holdings:
0.013 = S$7.7m ÷ (S$694m - S$114m) (Based on the trailing twelve months to December 2019.)
Therefore, G. K. Goh Holdings has an ROCE of 1.3%.
Does G. K. Goh Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, G. K. Goh Holdings's ROCE appears to be significantly below the 14% average in the Professional Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside G. K. Goh Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
We can see that, G. K. Goh Holdings currently has an ROCE of 1.3%, less than the 2.6% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how G. K. Goh Holdings's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if G. K. Goh Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How G. K. Goh Holdings's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
G. K. Goh Holdings has current liabilities of S$114m and total assets of S$694m. As a result, its current liabilities are equal to approximately 16% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On G. K. Goh Holdings's ROCE
That's not a bad thing, however G. K. Goh Holdings has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like G. K. Goh Holdings 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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.