Today we’ll evaluate Majesco (NASDAQ:MJCO) 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.
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. In general, businesses with a higher ROCE are usually better quality. 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 Majesco:
0.14 = US$8.5m ÷ (US$114m – US$52m) (Based on the trailing twelve months to December 2018.)
So, Majesco has an ROCE of 14%.
Is Majesco’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Majesco’s ROCE is meaningfully higher than the 9.3% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Majesco compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Majesco delivered an ROCE of 14%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. If Majesco is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Majesco’s Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Majesco has total liabilities of US$52m and total assets of US$114m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. With this level of current liabilities, Majesco’s ROCE is boosted somewhat.
The Bottom Line On Majesco’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. You might be able to find a better buy than Majesco. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 firstname.lastname@example.org. 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.