Today we’ll evaluate Evolving Systems, Inc. (NASDAQ:EVOL) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to 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.
Understanding Return On Capital Employed (ROCE)
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. Overall, it is a valuable metric that has its flaws. 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 Evolving Systems:
0.079 = US$3.0m ÷ (US$52m – US$14m) (Based on the trailing twelve months to September 2018.)
Therefore, Evolving Systems has an ROCE of 7.9%.
Does Evolving Systems Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Evolving Systems’s ROCE is fairly close to the Software industry average of 9.3%. Setting aside the industry comparison for now, Evolving Systems’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Evolving Systems’s current ROCE of 7.9% is lower than its ROCE in the past, which was 13%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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, after all, simply a snap shot of a single year. If Evolving Systems is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Evolving Systems’s Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Evolving Systems has total liabilities of US$14m and total assets of US$52m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Evolving Systems’s ROCE
If Evolving Systems continues to earn an uninspiring ROCE, there may be better places to invest. Of course you might be able to find a better stock than Evolving Systems. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.