Today we’ll look at Adobe Inc. (NASDAQ:ADBE) and reflect on its potential as an investment. 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.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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 ‘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. 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?
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 Adobe:
0.20 = US$2.8b ÷ (US$19b – US$4.3b) (Based on the trailing twelve months to November 2018.)
So, Adobe has an ROCE of 20%.
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Does Adobe Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Adobe’s ROCE is meaningfully higher than the 9.5% 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. Separate from Adobe’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Adobe currently has an ROCE of 20%, compared to its ROCE of 9.5% 3 years ago. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and 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, 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 Adobe.
Adobe’s Current Liabilities And Their Impact On Its 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Adobe has total liabilities of US$4.3b and total assets of US$19b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Adobe’s ROCE
Overall, Adobe has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than Adobe. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Adobe better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.