What Can We Make Of Intelligent Systems Corporation’s (NYSEMKT:INS) High Return On Capital?

Today we'll evaluate Intelligent Systems Corporation (NYSEMKT:INS) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. 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 Intelligent Systems:

0.34 = US$12m ÷ (US$40m - US$5.5m) (Based on the trailing twelve months to September 2019.)

Therefore, Intelligent Systems has an ROCE of 34%.

Check out our latest analysis for Intelligent Systems

Is Intelligent Systems's ROCE Good?

One way to assess ROCE is to compare similar companies. Intelligent Systems's ROCE appears to be substantially greater than the 9.8% 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 34%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Intelligent Systems's past growth compares to other companies.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Intelligent Systems.

What Are Current Liabilities, And How Do They Affect Intelligent Systems's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Intelligent Systems has total assets of US$40m and current liabilities of US$5.5m. As a result, its current liabilities are equal to approximately 14% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

Our Take On Intelligent Systems's ROCE

, There might be better investments than Intelligent Systems 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.

I will like Intelligent Systems better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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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