Is rhipe Limited (ASX:RHP) Investing Effectively In Its Business?

Today we'll look at rhipe Limited (ASX:RHP) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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.

So, How Do We Calculate ROCE?

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 rhipe:

0.12 = AU$7.9m ÷ (AU$113m - AU$49m) (Based on the trailing twelve months to December 2019.)

So, rhipe has an ROCE of 12%.

See our latest analysis for rhipe

Is rhipe's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, rhipe's ROCE appears to be around the 12% average of the IT industry. Regardless of where rhipe sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

rhipe has an ROCE of 12%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. The image below shows how rhipe's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for rhipe.

How rhipe's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

rhipe has current liabilities of AU$49m and total assets of AU$113m. As a result, its current liabilities are equal to approximately 43% of its total assets. rhipe has a medium level of current liabilities, which would boost the ROCE.

The Bottom Line On rhipe's ROCE

rhipe's ROCE does look good, but the level of current liabilities also contribute to that. rhipe 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.

I will like rhipe better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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