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Today we’ll evaluate AppFolio, Inc. (NASDAQ:APPF) 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.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?
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 AppFolio:
0.18 = US$9.3m ÷ (US$136m – US$21m) (Based on the trailing twelve months to September 2018.)
Therefore, AppFolio has an ROCE of 18%.
Does AppFolio Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. AppFolio’s ROCE appears to be substantially greater than the 9.5% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from AppFolio’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
AppFolio reported an ROCE of 18% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for AppFolio.
How AppFolio’s Current Liabilities Impact 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 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.
AppFolio has total assets of US$136m and current liabilities of US$21m. As a result, its current liabilities are equal to approximately 15% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On AppFolio’s ROCE
With that in mind, AppFolio’s ROCE appears pretty good. You might be able to find a better buy than AppFolio. 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).
I will like AppFolio better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. On rare occasion, data errors may occur. Thank you for reading.