Today we'll evaluate SPS Commerce, Inc. (NASDAQ:SPSC) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. Overall, it is a valuable metric that has its flaws. 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?
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:
0.10 = US$38m ÷ (US$447m - US$68m) (Based on the trailing twelve months to December 2019.)
So, SPS Commerce has an ROCE of 10%.
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. We can see SPS Commerce's ROCE is around the 9.4% average reported by the Software industry. Separate from SPS Commerce's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that SPS Commerce currently has an ROCE of 10%, compared to its ROCE of 2.4% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how SPS Commerce's ROCE compares to its industry. Click to see more on past growth.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for SPS Commerce.
SPS Commerce's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
SPS Commerce has current liabilities of US$68m and total assets of US$447m. As a result, its current liabilities are equal to approximately 15% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On SPS Commerce's ROCE
With that in mind, SPS Commerce's ROCE appears pretty good. There might be better investments than SPS Commerce out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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