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Are HMS Networks AB (publ)’s (STO:HMS) High Returns Really That Great?

Simply Wall St

Today we are going to look at HMS Networks AB (publ) (STO:HMS) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 HMS Networks:

0.17 = kr256m ÷ (kr1.9b - kr343m) (Based on the trailing twelve months to June 2019.)

So, HMS Networks has an ROCE of 17%.

Check out our latest analysis for HMS Networks

Does HMS Networks Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that HMS Networks's ROCE is meaningfully better than the 12% average in the Communications industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where HMS Networks 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 , HMS Networks currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 8.7%. 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 HMS Networks's past growth compares to other companies.

OM:HMS Past Revenue and Net Income, August 26th 2019

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. 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 HMS Networks.

HMS Networks's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counter this, investors can check if a company has high current liabilities relative to total assets.

HMS Networks has total liabilities of kr343m and total assets of kr1.9b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On HMS Networks's ROCE

This is good to see, and with a sound ROCE, HMS Networks could be worth a closer look. HMS Networks 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.

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.