Today we'll evaluate CDW Corporation (NASDAQ:CDW) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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?
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 CDW:
0.24 = US$1.1b ÷ (US$7.7b - US$3.2b) (Based on the trailing twelve months to September 2019.)
So, CDW has an ROCE of 24%.
Does CDW Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, CDW's ROCE is meaningfully higher than the 12% average in the Electronic 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, CDW's ROCE in absolute terms currently looks quite high.
We can see that, CDW currently has an ROCE of 24% compared to its ROCE 3 years ago, which was 17%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how CDW's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CDW.
CDW's Current Liabilities And Their Impact On Its 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
CDW has total assets of US$7.7b and current liabilities of US$3.2b. As a result, its current liabilities are equal to approximately 42% of its total assets. A medium level of current liabilities boosts CDW's ROCE somewhat.
What We Can Learn From CDW's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than CDW out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at email@example.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.