Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Is Employing Capital Very Effectively
Today we'll evaluate Cognizant Technology Solutions Corporation (NASDAQ:CTSH) 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.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. 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 Cognizant Technology Solutions:
0.21 = US$2.7b ÷ (US$16b - US$2.8b) (Based on the trailing twelve months to June 2019.)
So, Cognizant Technology Solutions has an ROCE of 21%.
View our latest analysis for Cognizant Technology Solutions
Does Cognizant Technology Solutions Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Cognizant Technology Solutions's ROCE appears to be substantially greater than the 10% average in the IT 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, Cognizant Technology Solutions's ROCE currently appears to be excellent.
You can click on the image below to see (in greater detail) how Cognizant Technology Solutions'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. 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 Cognizant Technology Solutions.
How Cognizant Technology Solutions's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cognizant Technology Solutions has total liabilities of US$2.8b and total assets of US$16b. As a result, its current liabilities are equal to approximately 18% 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 Cognizant Technology Solutions's ROCE
With low current liabilities and a high ROCE, Cognizant Technology Solutions could be worthy of further investigation. Cognizant Technology Solutions 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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. Thank you for reading.
