Today we'll look at The Descartes Systems Group Inc (TSE:DSG) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is 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. 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. 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 Descartes Systems Group:
0.064 = US$54m ÷ (US$943m - US$91m) (Based on the trailing twelve months to October 2019.)
So, Descartes Systems Group has an ROCE of 6.4%.
Does Descartes Systems Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Descartes Systems Group's ROCE is meaningfully below the Software industry average of 10%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Descartes Systems Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
You can click on the image below to see (in greater detail) how Descartes Systems Group's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Descartes Systems Group'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Descartes Systems Group has current liabilities of US$91m and total assets of US$943m. As a result, its current liabilities are equal to approximately 9.7% of its total assets. With low levels of current liabilities, at least Descartes Systems Group's mediocre ROCE is not unduly boosted.
The Bottom Line On Descartes Systems Group's ROCE
If performance improves, then Descartes Systems Group may be an OK investment, especially at the right valuation. You might be able to find a better investment than Descartes Systems Group. 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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