Today we’ll evaluate Check Point Software Technologies Ltd. (NASDAQ:CHKP) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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. All else being equal, a better business will have a higher ROCE. 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 Check Point Software Technologies:
0.21 = US$876m ÷ (US$5.6b – US$1.4b) (Based on the trailing twelve months to March 2020.)
So, Check Point Software Technologies has an ROCE of 21%.
Check out our latest analysis for Check Point Software Technologies
Is Check Point Software Technologies’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Check Point Software Technologies’s ROCE is meaningfully higher than the 9.7% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Check Point Software Technologies’s ROCE currently appears to be excellent.
You can see in the image below how Check Point Software Technologies’s ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Check Point Software Technologies.
Check Point Software Technologies’s Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Check Point Software Technologies has current liabilities of US$1.4b and total assets of US$5.6b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On Check Point Software Technologies’s ROCE
With low current liabilities and a high ROCE, Check Point Software Technologies could be worthy of further investigation. Check Point Software Technologies looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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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