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Today we’ll look at Teradata Corporation (NYSE:TDC) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Teradata:
0.036 = US$48m ÷ (US$2.4b – US$1.0b) (Based on the trailing twelve months to December 2018.)
So, Teradata has an ROCE of 3.6%.
Is Teradata’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Teradata’s ROCE is meaningfully below the Software industry average of 9.4%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Teradata’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
As we can see, Teradata currently has an ROCE of 3.6%, less than the 19% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 Teradata.
Do Teradata’s Current Liabilities Skew Its 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 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.
Teradata has total liabilities of US$1.0b and total assets of US$2.4b. As a result, its current liabilities are equal to approximately 43% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Teradata’s low ROCE is unappealing.
What We Can Learn From Teradata’s ROCE
This company may not be the most attractive investment prospect. But note: Teradata may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Teradata better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 firstname.lastname@example.org.