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Today we’ll evaluate Amdocs Limited (NASDAQ:DOX) 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. 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. In general, businesses with a higher ROCE are usually better quality. 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’.
How Do You Calculate Return On Capital Employed?
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 Amdocs:
0.13 = US$513m ÷ (US$5.3b – US$1.3b) (Based on the trailing twelve months to September 2018.)
So, Amdocs has an ROCE of 13%.
Is Amdocs’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Amdocs’s ROCE appears to be substantially greater than the 10% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Amdocs’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Amdocs.
What Are Current Liabilities, And How Do They Affect Amdocs’s 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Amdocs has total liabilities of US$1.3b and total assets of US$5.3b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Amdocs’s ROCE
This is good to see, and with a sound ROCE, Amdocs could be worth a closer look. You might be able to find a better buy than Amdocs. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 firstname.lastname@example.org.