Examining NetScout Systems, Inc.’s (NASDAQ:NTCT) Weak Return On Capital Employed

Today we'll evaluate NetScout Systems, Inc. (NASDAQ:NTCT) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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'.

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 NetScout Systems:

0.013 = US$36m ÷ (US$3.1b - US$384m) (Based on the trailing twelve months to December 2019.)

So, NetScout Systems has an ROCE of 1.3%.

View our latest analysis for NetScout Systems

Does NetScout Systems Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see NetScout Systems's ROCE is meaningfully below the Communications industry average of 5.9%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how NetScout Systems compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. Readers may wish to look for more rewarding investments.

We can see that, NetScout Systems currently has an ROCE of 1.3% compared to its ROCE 3 years ago, which was 0.9%. This makes us wonder if the company is improving. The image below shows how NetScout Systems'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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 NetScout Systems.

Do NetScout Systems's Current Liabilities Skew Its 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 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.

NetScout Systems has total assets of US$3.1b and current liabilities of US$384m. As a result, its current liabilities are equal to approximately 12% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

Our Take On NetScout Systems's ROCE

While that is good to see, NetScout Systems has a low ROCE and does not look attractive in this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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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.