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Is DLH Holdings Corp.'s (NASDAQ:DLHC) Capital Allocation Ability Worth Your Time?

Simply Wall St

Today we'll look at DLH Holdings Corp. (NASDAQ:DLHC) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 DLH Holdings:

0.10 = US$11m ÷ (US$135m - US$28m) (Based on the trailing twelve months to June 2019.)

So, DLH Holdings has an ROCE of 10%.

See our latest analysis for DLH Holdings

Does DLH Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, DLH Holdings's ROCE appears to be around the 12% average of the Professional Services industry. Setting aside the industry comparison for now, DLH Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

In our analysis, DLH Holdings's ROCE appears to be 10%, compared to 3 years ago, when its ROCE was 7.5%. This makes us wonder if the company is improving. You can see in the image below how DLH Holdings's ROCE compares to its industry. Click to see more on past growth.

NasdaqCM:DLHC Past Revenue and Net Income, October 14th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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.

What Are Current Liabilities, And How Do They Affect DLH Holdings's 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.

DLH Holdings has total liabilities of US$28m and total assets of US$135m. As a result, its current liabilities are equal to approximately 21% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From DLH Holdings's ROCE

That said, DLH Holdings's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than DLH Holdings. 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).

I will like DLH Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.