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Today we’ll look at Aware, Inc. (NASDAQ:AWRE) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Aware:
0.017 = US$1.1m ÷ (US$66m – US$3.8m) (Based on the trailing twelve months to March 2019.)
Therefore, Aware has an ROCE of 1.7%.
Does Aware Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Aware’s ROCE appears to be significantly below the 9.5% average in the Software industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Aware compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
Aware’s current ROCE of 1.7% is lower than 3 years ago, when the company reported a 7.7% ROCE. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. ROCE is only a point-in-time measure. How cyclical is Aware? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Aware’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Aware has total assets of US$66m and current liabilities of US$3.8m. Therefore its current liabilities are equivalent to approximately 5.8% of its total assets. With barely any current liabilities, there is minimal impact on Aware’s admittedly low ROCE.
What We Can Learn From Aware’s ROCE
Nonetheless, there may be better places to invest your capital. Of course, you might also be able to find a better stock than Aware. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Aware 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 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.