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What Can We Make Of CGI Inc.’s (TSE:GIB.A) High Return On Capital?

Today we'll look at CGI Inc. (TSE:GIB.A) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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:

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

Or for CGI:

0.19 = CA$1.8b ÷ (CA$13b - CA$3.1b) (Based on the trailing twelve months to June 2019.)

So, CGI has an ROCE of 19%.

View our latest analysis for CGI

Does CGI Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, CGI's ROCE is meaningfully higher than the 10% average in the IT industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from CGI's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

You can see in the image below how CGI's ROCE compares to its industry. Click to see more on past growth.

TSX:GIB.A Past Revenue and Net Income, August 9th 2019
TSX:GIB.A Past Revenue and Net Income, August 9th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How CGI'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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

CGI has total assets of CA$13b and current liabilities of CA$3.1b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From CGI's ROCE

Overall, CGI has a decent ROCE and could be worthy of further research. CGI shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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.