Today we'll look at Fortinet, Inc. (NASDAQ:FTNT) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, 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.
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. All else being equal, a better business will have a higher ROCE. 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'.
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 Fortinet:
0.14 = US$311m ÷ (US$3.5b - US$1.3b) (Based on the trailing twelve months to September 2019.)
Therefore, Fortinet has an ROCE of 14%.
Is Fortinet's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Fortinet's ROCE is meaningfully better than the 9.8% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Fortinet sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Fortinet currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 1.3%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Fortinet's past growth compares to other companies.
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 Fortinet.
Fortinet'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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Fortinet has total liabilities of US$1.3b and total assets of US$3.5b. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Fortinet has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Fortinet's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Fortinet 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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