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Why Solution Dynamics Limited’s (NZSE:SDL) Return On Capital Employed Is Impressive

Today we are going to look at Solution Dynamics Limited (NZSE:SDL) to see whether it might be an attractive investment prospect. 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.

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.

Return On Capital Employed (ROCE): What is it?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed 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. 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 Solution Dynamics:

0.51 = NZ\$1.9m ÷ (NZ\$7.4m – NZ\$3.6m) (Based on the trailing twelve months to December 2018.)

So, Solution Dynamics has an ROCE of 51%.

Does Solution Dynamics Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Solution Dynamics’s ROCE is meaningfully better than the 13% average in the IT industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Solution Dynamics’s ROCE is currently very good.

Our data shows that Solution Dynamics currently has an ROCE of 51%, compared to its ROCE of 37% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. If Solution Dynamics is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Solution Dynamics’s 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Solution Dynamics has total assets of NZ\$7.4m and current liabilities of NZ\$3.6m. As a result, its current liabilities are equal to approximately 49% of its total assets. Solution Dynamics has a medium level of current liabilities, boosting its ROCE somewhat.

The Bottom Line On Solution Dynamics’s ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. Solution Dynamics 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 Solution Dynamics better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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. Thank you for reading.