Today we are going to look at Intelligent Systems Corporation (NYSEMKT:INS) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. 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?
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 Intelligent Systems:
0.34 = US$12m ÷ (US$40m - US$5.5m) (Based on the trailing twelve months to September 2019.)
Therefore, Intelligent Systems has an ROCE of 34%.
Is Intelligent Systems's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Intelligent Systems's ROCE is meaningfully higher than the 9.8% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Intelligent Systems's ROCE currently appears to be excellent.
Intelligent Systems delivered an ROCE of 34%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. The image below shows how Intelligent Systems's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Intelligent Systems's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Intelligent Systems has total liabilities of US$5.5m and total assets of US$40m. As a result, its current liabilities are equal to approximately 14% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
Our Take On Intelligent Systems's ROCE
With low current liabilities and a high ROCE, Intelligent Systems could be worthy of further investigation. Intelligent Systems 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.
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