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Does Greene King plc’s (LON:GNK) ROCE Reflect Well On The Business?

Today we'll look at Greene King plc (LON:GNK) and reflect on its potential as an investment. 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.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. 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?

The formula for calculating the return on capital employed is:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Greene King:

0.079 = UK£366m ÷ (UK£5.2b - UK£546m) (Based on the trailing twelve months to October 2018.)

So, Greene King has an ROCE of 7.9%.

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See our latest analysis for Greene King

Is Greene King's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. It appears that Greene King's ROCE is fairly close to the Hospitality industry average of 8.3%. Setting aside the industry comparison for now, Greene King's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

LSE:GNK Past Revenue and Net Income, May 15th 2019
LSE:GNK Past Revenue and Net Income, May 15th 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Greene King.

Do Greene King's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Greene King has total liabilities of UK£546m and total assets of UK£5.2b. As a result, its current liabilities are equal to approximately 11% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On Greene King's ROCE

With that in mind, we're not overly impressed with Greene King's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Greene King. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.