In This Article:
Today we'll evaluate The Gym Group plc (LON:GYM) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 Gym Group:
0.041 = UK£17m ÷ (UK£471m - UK£44m) (Based on the trailing twelve months to June 2019.)
So, Gym Group has an ROCE of 4.1%.
View our latest analysis for Gym Group
Is Gym Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Gym Group's ROCE is meaningfully below the Hospitality industry average of 7.6%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Gym Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. There are potentially more appealing investments elsewhere.
Gym Group delivered an ROCE of 4.1%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how Gym Group's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Gym Group.
What Are Current Liabilities, And How Do They Affect Gym 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.