Today we are going to look at DATA Communications Management Corp. (TSE:DCM) 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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’.
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 DATA Communications Management:
0.15 = CA$12m ÷ (CA$142m – CA$65m) (Based on the trailing twelve months to December 2018.)
So, DATA Communications Management has an ROCE of 15%.
Does DATA Communications Management Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that DATA Communications Management’s ROCE is meaningfully better than the 9.7% average in the Commercial Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how DATA Communications Management compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, DATA Communications Management currently has an ROCE of 15%, less than the 32% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. ROCE is only a point-in-time measure. You can check if DATA Communications Management has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do DATA Communications Management’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
DATA Communications Management has total assets of CA$142m and current liabilities of CA$65m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. DATA Communications Management has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From DATA Communications Management’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. But note: DATA Communications Management may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. Thank you for reading.