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Today we’ll look at Intelligent Systems Corporation (NYSEMKT:INS) and reflect on its potential as an investment. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Intelligent Systems:
0.28 = US$7.9m ÷ (US$34m – US$5.1m) (Based on the trailing twelve months to March 2019.)
Therefore, Intelligent Systems has an ROCE of 28%.
Is Intelligent Systems’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Intelligent Systems’s ROCE is meaningfully better than the 9.5% average in the Software industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Intelligent Systems’s ROCE currently appears to be excellent.
Intelligent Systems delivered an ROCE of 28%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving.
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. ROCE is only a point-in-time measure. If Intelligent Systems is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Intelligent Systems’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Intelligent Systems has total liabilities of US$5.1m and total assets of US$34m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
The Bottom Line On Intelligent Systems’s ROCE
This is good to see, and with such a high ROCE, Intelligent Systems may be worth a closer look. Intelligent Systems looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.