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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. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. 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. In general, businesses with a higher ROCE are usually better quality. 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'.

So, How Do We Calculate ROCE?

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:

0.18 = CA$1.9b ÷ (CA$14b - CA$3.5b) (Based on the trailing twelve months to December 2019.)

Therefore, CGI has an ROCE of 18%.

View our latest analysis for CGI

Is CGI's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, CGI's ROCE is meaningfully higher than the 12% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where CGI sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

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, February 24th 2020
TSX:GIB.A Past Revenue and Net Income, February 24th 2020

It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

CGI has current liabilities of CA$3.5b and total assets of CA$14b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On CGI's ROCE

This is good to see, and with a sound ROCE, CGI could be worth a closer look. 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.

CGI is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.