Today we'll evaluate Qualstar Corporation (NASDAQ:QBAK) 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, we'll go over how we 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.
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. Generally speaking a higher ROCE is better. 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'.
So, How Do We Calculate ROCE?
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 Qualstar:
0.094 = US$725k ÷ (US$11m - US$2.9m) (Based on the trailing twelve months to June 2019.)
So, Qualstar has an ROCE of 9.4%.
Is Qualstar's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Qualstar's ROCE appears to be around the 9.4% average of the Tech industry. Setting aside the industry comparison for now, Qualstar's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Qualstar reported an ROCE of 9.4% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how Qualstar'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. 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. How cyclical is Qualstar? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Qualstar's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Qualstar has total assets of US$11m and current liabilities of US$2.9m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Qualstar's ROCE
With that in mind, we're not overly impressed with Qualstar's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Qualstar. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.