Today we are going to look at SoftTech Engineers Limited (NSE:SOFTTECH) 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for SoftTech Engineers:
0.14 = ₹91m ÷ (₹885m – ₹214m) (Based on the trailing twelve months to September 2019.)
Therefore, SoftTech Engineers has an ROCE of 14%.
Does SoftTech Engineers Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that SoftTech Engineers’s ROCE is meaningfully better than the 11% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how SoftTech Engineers stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
SoftTech Engineers’s current ROCE of 14% is lower than its ROCE in the past, which was 22%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how SoftTech Engineers’s past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If SoftTech Engineers is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How SoftTech Engineers’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. 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.
SoftTech Engineers has total assets of ₹885m and current liabilities of ₹214m. As a result, its current liabilities are equal to approximately 24% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
Our Take On SoftTech Engineers’s ROCE
That said, SoftTech Engineers’s ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than SoftTech Engineers. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like SoftTech Engineers better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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