Today we'll look at Connexion Telematics Ltd (ASX:CXZ) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
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. 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.
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 Connexion Telematics:
0.51 = AU$1.8m ÷ (AU$5.1m - AU$1.7m) (Based on the trailing twelve months to December 2019.)
Therefore, Connexion Telematics has an ROCE of 51%.
Is Connexion Telematics's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Connexion Telematics's ROCE appears to be substantially greater than the 16% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Connexion Telematics's ROCE is currently very good.
You can click on the image below to see (in greater detail) how Connexion Telematics's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. If Connexion Telematics is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Connexion Telematics'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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Connexion Telematics has total assets of AU$5.1m and current liabilities of AU$1.7m. As a result, its current liabilities are equal to approximately 33% of its total assets. Connexion Telematics has a medium level of current liabilities, boosting its ROCE somewhat.
The Bottom Line On Connexion Telematics's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Connexion Telematics looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
Connexion Telematics is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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