Today we are going to look at CDK Global, Inc. (NASDAQ:CDK) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 CDK Global:
0.26 = US$639m ÷ (US$3.1b – US$501m) (Based on the trailing twelve months to September 2018.)
So, CDK Global has an ROCE of 26%.
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Is CDK Global’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, CDK Global’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. Regardless of the industry comparison, in absolute terms, CDK Global’s ROCE currently appears to be excellent.
Our data shows that CDK Global currently has an ROCE of 26%, compared to its ROCE of 19% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for CDK Global.
How CDK Global’s Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
CDK Global has total liabilities of US$501m and total assets of US$3.1b. As a result, its current liabilities are equal to approximately 16% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great 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. You might be able to find a better buy than CDK Global. 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).
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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.