Today we are going to look at Digi International Inc. (NASDAQ:DGII) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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.
So, How Do We Calculate ROCE?
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 Digi International:
0.017 = US$8.5m ÷ (US$561m - US$62m) (Based on the trailing twelve months to December 2019.)
Therefore, Digi International has an ROCE of 1.7%.
Is Digi International's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Digi International's ROCE is meaningfully below the Communications industry average of 6.3%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Digi International's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
We can see that, Digi International currently has an ROCE of 1.7%, less than the 5.1% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Digi International's ROCE compares to its industry. Click to see more on 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Digi International.
Do Digi International's Current Liabilities Skew Its 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Digi International has current liabilities of US$62m and total assets of US$561m. As a result, its current liabilities are equal to approximately 11% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On Digi International's ROCE
That's not a bad thing, however Digi International has a weak ROCE and may not be an attractive investment. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
Digi International is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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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