Is SPS Commerce, Inc. (NASDAQ:SPSC) Better Than Average At Deploying Capital?

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Today we'll look at SPS Commerce, Inc. (NASDAQ:SPSC) 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.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from 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.'

So, How Do We Calculate ROCE?

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 SPS Commerce:

0.084 = US$30m ÷ (US$407m - US$53m) (Based on the trailing twelve months to March 2019.)

Therefore, SPS Commerce has an ROCE of 8.4%.

Check out our latest analysis for SPS Commerce

Does SPS Commerce Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, SPS Commerce's ROCE appears to be around the 9.5% average of the Software industry. Aside from the industry comparison, SPS Commerce's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Our data shows that SPS Commerce currently has an ROCE of 8.4%, compared to its ROCE of 3.0% 3 years ago. This makes us wonder if the company is improving.

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. 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 SPS Commerce.

How SPS Commerce's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

SPS Commerce has total assets of US$407m and current liabilities of US$53m. As a result, its current liabilities are equal to approximately 13% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On SPS Commerce's ROCE

That said, SPS Commerce's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than SPS Commerce. So you may wish to see this free collection of other companies that have grown earnings strongly.

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 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. Thank you for reading.