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Examining CoStar Group, Inc.’s (NASDAQ:CSGP) Weak Return On Capital Employed

Simply Wall St

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Today we are going to look at CoStar Group, Inc. (NASDAQ:CSGP) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, 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.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from 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 CoStar Group:

0.094 = US$315m ÷ (US$3.5b - US$198m) (Based on the trailing twelve months to March 2019.)

Therefore, CoStar Group has an ROCE of 9.4%.

View our latest analysis for CoStar Group

Is CoStar Group's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see CoStar Group's ROCE is meaningfully below the Professional Services industry average of 12%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, CoStar Group'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.

In our analysis, CoStar Group's ROCE appears to be 9.4%, compared to 3 years ago, when its ROCE was 2.3%. This makes us think the business might be improving.

NasdaqGS:CSGP Past Revenue and Net Income, June 4th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for CoStar Group.

How CoStar Group's Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.

CoStar Group has total liabilities of US$198m and total assets of US$3.5b. As a result, its current liabilities are equal to approximately 5.6% of its total assets. CoStar Group reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On CoStar Group's ROCE

If performance improves, then CoStar Group may be an OK investment, especially at the right valuation. You might be able to find a better investment than CoStar Group. 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 are like me, then you will not want to miss this free list of growing companies that insiders are 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.