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Why We’re Not Keen On Gray Television, Inc.’s (NYSE:GTN) 6.8% Return On Capital

Simply Wall St

Today we are going to look at Gray Television, Inc. (NYSE:GTN) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. In brief, it is a useful tool, but it is not without drawbacks. 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 Gray Television:

0.068 = US$460m ÷ (US$7.0b - US$233m) (Based on the trailing twelve months to June 2019.)

Therefore, Gray Television has an ROCE of 6.8%.

Check out our latest analysis for Gray Television

Is Gray Television's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Gray Television's ROCE is meaningfully below the Media industry average of 9.0%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Gray Television stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

The image below shows how Gray Television's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:GTN Past Revenue and Net Income, October 10th 2019

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Gray Television.

How Gray Television's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Gray Television has total assets of US$7.0b and current liabilities of US$233m. Therefore its current liabilities are equivalent to approximately 3.3% of its total assets. Gray Television reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On Gray Television's ROCE

Based on this information, Gray Television appears to be a mediocre business. 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.