Today we'll evaluate DWS Limited (ASX:DWS) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from 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 DWS:
0.18 = AU$20m ÷ (AU$144m - AU$30m) (Based on the trailing twelve months to June 2019.)
Therefore, DWS has an ROCE of 18%.
See our latest analysis for DWS
Does DWS Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, DWS's ROCE appears to be around the 15% average of the IT industry. Independently of how DWS compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
DWS's current ROCE of 18% is lower than its ROCE in the past, which was 28%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how DWS's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 DWS.
What Are Current Liabilities, And How Do They Affect DWS's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
DWS has total liabilities of AU$30m and total assets of AU$144m. As a result, its current liabilities are equal to approximately 21% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On DWS's ROCE
With that in mind, DWS's ROCE appears pretty good. DWS 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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