Today we are going to look at Cadence Design Systems, Inc. (NASDAQ:CDNS) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
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 measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
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 Cadence Design Systems:
0.19 = US$503m ÷ (US$3.4b – US$672m) (Based on the trailing twelve months to December 2019.)
Therefore, Cadence Design Systems has an ROCE of 19%.
Is Cadence Design Systems’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Cadence Design Systems’s ROCE appears to be substantially greater than the 9.9% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Cadence Design Systems’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 Cadence Design Systems’s ROCE compares to its industry. Click to see more on past growth.
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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Cadence Design Systems’s Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Cadence Design Systems has total assets of US$3.4b and current liabilities of US$672m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Cadence Design Systems’s ROCE
With that in mind, Cadence Design Systems’s ROCE appears pretty good. Cadence Design Systems looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at email@example.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.
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