Today we’ll evaluate DLH Holdings Corp. (NASDAQ:DLHC) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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’.
So, How Do We Calculate ROCE?
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 DLH Holdings:
0.21 = US$8.8m ÷ (US$64m – US$15m) (Based on the trailing twelve months to December 2018.)
Therefore, DLH Holdings has an ROCE of 21%.
Does DLH Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. DLH Holdings’s ROCE appears to be substantially greater than the 13% average in the Professional Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, DLH Holdings’s ROCE currently appears to be excellent.
In our analysis, DLH Holdings’s ROCE appears to be 21%, compared to 3 years ago, when its ROCE was 11%. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and 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 DLH Holdings.
How DLH Holdings’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 counter this, investors can check if a company has high current liabilities relative to total assets.
DLH Holdings has total liabilities of US$15m and total assets of US$64m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On DLH Holdings’s ROCE
With low current liabilities and a high ROCE, DLH Holdings could be worthy of further investigation. But note: DLH Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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 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. Thank you for reading.