Today we are going to look at Datamatics Global Services Limited (NSE:DATAMATICS) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Datamatics Global Services:
0.16 = ₹1.1b ÷ (₹8.7b - ₹1.6b) (Based on the trailing twelve months to June 2019.)
So, Datamatics Global Services has an ROCE of 16%.
Is Datamatics Global Services's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Datamatics Global Services's ROCE is around the 14% average reported by the IT industry. Separate from Datamatics Global Services's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Datamatics Global Services currently has an ROCE of 16% compared to its ROCE 3 years ago, which was 9.1%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Datamatics Global Services's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. 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 Datamatics Global Services's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Datamatics Global Services has total assets of ₹8.7b and current liabilities of ₹1.6b. Therefore its current liabilities are equivalent to approximately 19% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Datamatics Global Services's ROCE
With that in mind, Datamatics Global Services's ROCE appears pretty good. Datamatics Global Services 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.
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