Today we are going to look at Fair Isaac Corporation (NYSE:FICO) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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’.
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 Fair Isaac:
0.25 = US$219m ÷ (US$1.3b – US$433m) (Based on the trailing twelve months to December 2018.)
Therefore, Fair Isaac has an ROCE of 25%.
Is Fair Isaac’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Fair Isaac’s ROCE is meaningfully better than the 9.1% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Fair Isaac’s ROCE in absolute terms currently looks quite high.
Our data shows that Fair Isaac currently has an ROCE of 25%, compared to its ROCE of 17% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Fair Isaac.
What Are Current Liabilities, And How Do They Affect Fair Isaac’s 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Fair Isaac has total assets of US$1.3b and current liabilities of US$433m. As a result, its current liabilities are equal to approximately 33% of its total assets. Fair Isaac has a medium level of current liabilities, boosting its ROCE somewhat.
The Bottom Line On Fair Isaac’s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. But note: Fair Isaac may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 email@example.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.