Today we’ll evaluate Cisco Systems, Inc. (NASDAQ:CSCO) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
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 Cisco Systems:
0.21 = US$14b ÷ (US$90b – US$22b) (Based on the trailing twelve months to January 2020.)
So, Cisco Systems has an ROCE of 21%.
Is Cisco Systems’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Cisco Systems’s ROCE is meaningfully higher than the 6.1% average in the Communications 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, Cisco Systems’s ROCE currently appears to be excellent.
Our data shows that Cisco Systems currently has an ROCE of 21%, compared to its ROCE of 12% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Cisco Systems’s past growth compares to other companies.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cisco Systems.
What Are Current Liabilities, And How Do They Affect Cisco Systems’s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Cisco Systems has current liabilities of US$22b and total assets of US$90b. As a result, its current liabilities are equal to approximately 24% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
The Bottom Line On Cisco Systems’s ROCE
This is good to see, and with such a high ROCE, Cisco Systems may be worth a closer look. Cisco Systems 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.
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 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.
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