Today we'll evaluate Endava plc (NYSE:DAVA) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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?
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 Endava:
0.17 = UK£37m ÷ (UK£277m - UK£63m) (Based on the trailing twelve months to September 2019.)
So, Endava has an ROCE of 17%.
Is Endava's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Endava's ROCE is meaningfully better than the 12% average in the IT industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Endava'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, Endava currently has an ROCE of 17%, less than the 57% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Endava's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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 Endava.
How Endava's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Endava has total assets of UK£277m and current liabilities of UK£63m. As a result, its current liabilities are equal to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Endava's ROCE
This is good to see, and with a sound ROCE, Endava could be worth a closer look. Endava shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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