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Should You Like The Gorman-Rupp Company’s (NYSE:GRC) High Return On Capital Employed?

Simply Wall St

Today we’ll evaluate The Gorman-Rupp Company ( NYSE:GRC ) to determine whether it could have potential as an investment idea. 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. 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 measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?

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 Gorman-Rupp:

0.15 = US$49m ÷ (US$368m – US$48m) (Based on the trailing twelve months to December 2018.)

Therefore, Gorman-Rupp has an ROCE of 15%.

Check out our latest analysis for Gorman-Rupp

Does Gorman-Rupp Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Gorman-Rupp’s ROCE appears to be substantially greater than the 12% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Gorman-Rupp’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

In our analysis, Gorman-Rupp’s ROCE appears to be 15%, compared to 3 years ago, when its ROCE was 12%. This makes us think about whether the company has been reinvesting shrewdly.

NYSE:GRC Past Revenue and Net Income, March 18th 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Gorman-Rupp .

How Gorman-Rupp’s Current Liabilities Impact Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Gorman-Rupp has total assets of US$368m and current liabilities of US$48m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

The Bottom Line On Gorman-Rupp’s ROCE

Overall, Gorman-Rupp has a decent ROCE and could be worthy of further research. 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 Gorman-Rupp better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.