Why Gatekeeper Systems Inc.’s (CVE:GSI) Return On Capital Employed Might Be A Concern

Today we are going to look at Gatekeeper Systems Inc. (CVE:GSI) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. 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 Gatekeeper Systems:

0.054 = CA$379k ÷ (CA$8.9m - CA$1.9m) (Based on the trailing twelve months to November 2019.)

Therefore, Gatekeeper Systems has an ROCE of 5.4%.

Check out our latest analysis for Gatekeeper Systems

Does Gatekeeper Systems Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Gatekeeper Systems's ROCE is meaningfully below the Electronic industry average of 9.1%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Gatekeeper Systems stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Gatekeeper Systems's current ROCE of 5.4% is lower than its ROCE in the past, which was 35%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Gatekeeper Systems's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. If Gatekeeper Systems is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Gatekeeper Systems'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. 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.

Gatekeeper Systems has current liabilities of CA$1.9m and total assets of CA$8.9m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Gatekeeper Systems's ROCE

If Gatekeeper Systems continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Gatekeeper Systems. 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).

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.

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. Thank you for reading.