Today we are going to look at AudioCodes Ltd. (NASDAQ:AUDC) 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. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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.'
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 AudioCodes:
0.14 = US$20m ÷ (US$225m - US$74m) (Based on the trailing twelve months to June 2019.)
Therefore, AudioCodes has an ROCE of 14%.
Is AudioCodes's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, AudioCodes's ROCE is meaningfully higher than the 7.2% average in the Communications industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how AudioCodes compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that AudioCodes currently has an ROCE of 14%, compared to its ROCE of 4.0% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how AudioCodes'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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for AudioCodes.
What Are Current Liabilities, And How Do They Affect AudioCodes's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
AudioCodes has total assets of US$225m and current liabilities of US$74m. As a result, its current liabilities are equal to approximately 33% of its total assets. With this level of current liabilities, AudioCodes's ROCE is boosted somewhat.
Our Take On AudioCodes's ROCE
AudioCodes's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than AudioCodes out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like AudioCodes better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.