Today we are going to look at Innovative Solutions and Support, Inc. (NASDAQ:ISSC) to see whether it might be an attractive investment prospect. 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 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Innovative Solutions and Support:
0.006 = US$211k ÷ (US$38m - US$2.4m) (Based on the trailing twelve months to June 2019.)
Therefore, Innovative Solutions and Support has an ROCE of 0.6%.
Does Innovative Solutions and Support Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Innovative Solutions and Support's ROCE is meaningfully below the Aerospace & Defense industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Innovative Solutions and Support's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Innovative Solutions and Support delivered an ROCE of 0.6%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how Innovative Solutions and Support's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. ROCE is only a point-in-time measure. If Innovative Solutions and Support is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Innovative Solutions and Support'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.
Innovative Solutions and Support has total assets of US$38m and current liabilities of US$2.4m. As a result, its current liabilities are equal to approximately 6.4% of its total assets. Innovative Solutions and Support has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From Innovative Solutions and Support's ROCE
Nevertheless, there are potentially more attractive companies to invest in. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 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. Thank you for reading.