Today we are going to look at GB Group plc (LON:GBG) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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'.
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 GB Group:
0.044 = UK£19m ÷ (UK£510m - UK£72m) (Based on the trailing twelve months to March 2019.)
Therefore, GB Group has an ROCE of 4.4%.
Is GB Group's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, GB Group's ROCE appears to be significantly below the 11% average in the Software industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how GB Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
GB Group's current ROCE of 4.4% is lower than 3 years ago, when the company reported a 15% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how GB Group'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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for GB Group.
Do GB Group's Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
GB Group has total assets of UK£510m and current liabilities of UK£72m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On GB Group's ROCE
With that in mind, we're not overly impressed with GB Group's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than GB Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
There are plenty of other companies that have insiders buying up shares. You probably do 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 email@example.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.