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Why We Like GWA Group Limited’s (ASX:GWA) 13% Return On Capital Employed

Simply Wall St

Today we'll evaluate GWA Group Limited (ASX:GWA) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the 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?

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 GWA Group:

0.13 = AU$76m ÷ (AU$690m - AU$99m) (Based on the trailing twelve months to December 2019.)

So, GWA Group has an ROCE of 13%.

See our latest analysis for GWA Group

Is GWA Group's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that GWA Group's ROCE is meaningfully better than the 10% average in the Building industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where GWA Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

GWA Group's current ROCE of 13% is lower than its ROCE in the past, which was 18%, 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 GWA Group's past growth compares to other companies.

ASX:GWA Past Revenue and Net Income, February 18th 2020
ASX:GWA Past Revenue and Net Income, February 18th 2020

When considering this metric, keep in mind that it is backwards looking, and 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, 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 GWA Group.

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

GWA Group has total assets of AU$690m and current liabilities of AU$99m. As a result, its current liabilities are equal to approximately 14% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From GWA Group's ROCE

With that in mind, GWA Group's ROCE appears pretty good. GWA Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.