Today we’ll look at Paychex, Inc. (NASDAQ:PAYX) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
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. Ultimately, it is a useful but imperfect metric. 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?
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 Paychex:
0.36 = US$1.4b ÷ (US$10b – US$6.5b) (Based on the trailing twelve months to February 2019.)
So, Paychex has an ROCE of 36%.
Is Paychex’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Paychex’s ROCE appears to be substantially greater than the 11% 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. Regardless of the industry comparison, in absolute terms, Paychex’s ROCE currently appears to be excellent.
As we can see, Paychex currently has an ROCE of 36%, less than the 55% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Paychex’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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Paychex has total liabilities of US$6.5b and total assets of US$10b. Therefore its current liabilities are equivalent to approximately 63% of its total assets. Paychex’s high level of current liabilities boost the ROCE – but its ROCE is still impressive.
Our Take On Paychex’s ROCE
So we would be interested in doing more research here — there may be an opportunity! Paychex 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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