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Evolving Systems, Inc.’s (NASDAQ:EVOL) Investment Returns Are Lagging Its Industry

Today we’ll look at Evolving Systems, Inc. (NASDAQ:EVOL) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Evolving Systems:

0.079 = US$6.1m ÷ (US$52m – US$14m) (Based on the trailing twelve months to September 2018.)

So, Evolving Systems has an ROCE of 7.9%.

See our latest analysis for Evolving Systems

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Does Evolving Systems Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Evolving Systems’s ROCE is around the 9.5% average reported by the Software industry. Aside from the industry comparison, Evolving Systems’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.

Evolving Systems’s current ROCE of 7.9% is lower than 3 years ago, when the company reported a 13% ROCE. Therefore we wonder if the company is facing new headwinds.

NasdaqCM:EVOL Last Perf January 18th 19
NasdaqCM:EVOL Last Perf January 18th 19

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Evolving Systems? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do Evolving Systems’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Evolving Systems has total assets of US$52m and current liabilities of US$14m. As a result, its current liabilities are equal to approximately 27% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Evolving Systems’s ROCE

With that in mind, we’re not overly impressed with Evolving Systems’s ROCE, so it may not be the most appealing prospect. You might be able to find a better buy than Evolving Systems. 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).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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