What We Think Of International Business Machines Corporation’s (NYSE:IBM) Investment Potential

Today we'll evaluate International Business Machines Corporation (NYSE:IBM) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 International Business Machines:

0.094 = US$11b ÷ (US$152b - US$38b) (Based on the trailing twelve months to December 2019.)

Therefore, International Business Machines has an ROCE of 9.4%.

Check out our latest analysis for International Business Machines

Is International Business Machines's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, International Business Machines's ROCE appears to be around the 12% average of the IT industry. Setting aside the industry comparison for now, International Business Machines'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.

International Business Machines's current ROCE of 9.4% is lower than 3 years ago, when the company reported a 17% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how International Business Machines's ROCE compares to its industry, and you can click it to see more detail on its 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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do International Business Machines's Current Liabilities Skew Its ROCE?

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

International Business Machines has current liabilities of US$38b and total assets of US$152b. As a result, its current liabilities are equal to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From International Business Machines's ROCE

With that in mind, we're not overly impressed with International Business Machines's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than International Business Machines. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.