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Computer Modelling Group Ltd. (TSE:CMG) Earns A Nice Return On Capital Employed

Simply Wall St

Today we are going to look at Computer Modelling Group Ltd. (TSE:CMG) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Computer Modelling Group:

0.40 = CA$34m ÷ (CA$113m - CA$29m) (Based on the trailing twelve months to September 2019.)

Therefore, Computer Modelling Group has an ROCE of 40%.

Check out our latest analysis for Computer Modelling Group

Does Computer Modelling Group Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Computer Modelling Group's ROCE is meaningfully better than the 7.6% average in the Energy Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Computer Modelling Group's ROCE is currently very good.

Computer Modelling Group's current ROCE of 40% is lower than 3 years ago, when the company reported a 56% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Computer Modelling Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:CMG Past Revenue and Net Income, December 10th 2019

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. We note Computer Modelling Group could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Computer Modelling Group'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

Computer Modelling Group has total assets of CA$113m and current liabilities of CA$29m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.

Our Take On Computer Modelling Group's ROCE

With low current liabilities and a high ROCE, Computer Modelling Group could be worthy of further investigation. Computer Modelling Group 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 Computer Modelling Group 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.