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Today we are going to look at DXC Technology Company (NYSE:DXC) to see whether it might be an attractive investment prospect. 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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’.
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 DXC Technology:
0.16 = US$3.3b ÷ (US$29b – US$8.5b) (Based on the trailing twelve months to December 2018.)
Therefore, DXC Technology has an ROCE of 16%.
Does DXC Technology Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that DXC Technology’s ROCE is meaningfully better than the 11% average in the IT industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how DXC Technology compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, DXC Technology’s ROCE appears to be 16%, compared to 3 years ago, when its ROCE was 2.4%. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for DXC Technology.
Do DXC Technology’s Current Liabilities Skew Its 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
DXC Technology has total assets of US$29b and current liabilities of US$8.5b. As a result, its current liabilities are equal to approximately 30% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On DXC Technology’s ROCE
Overall, DXC Technology has a decent ROCE and could be worthy of further research. DXC Technology shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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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.