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CDK Global, Inc. (NASDAQ:CDK) Is Employing Capital Very Effectively

Simply Wall St

Today we are going to look at CDK Global, Inc. (NASDAQ:CDK) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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?

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 CDK Global:

0.27 = US$601m ÷ (US$3.1b - US$806m) (Based on the trailing twelve months to September 2019.)

So, CDK Global has an ROCE of 27%.

See our latest analysis for CDK Global

Is CDK Global's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that CDK Global's ROCE is meaningfully better than the 9.8% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, CDK Global's ROCE in absolute terms currently looks quite high.

You can click on the image below to see (in greater detail) how CDK Global's past growth compares to other companies.

NasdaqGS:CDK Past Revenue and Net Income, January 12th 2020

When considering this metric, keep in mind that it is backwards looking, and 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 CDK Global.

CDK Global's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

CDK Global has total assets of US$3.1b and current liabilities of US$806m. As a result, its current liabilities are equal to approximately 26% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

The Bottom Line On CDK Global's ROCE

This is good to see, and with such a high ROCE, CDK Global may be worth a closer look. CDK Global 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.

I will like CDK Global better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.