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Today we'll evaluate Leidos Holdings, Inc. (NYSE:LDOS) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 Leidos Holdings:
0.11 = US$786m ÷ (US$9.4b - US$2.3b) (Based on the trailing twelve months to March 2019.)
Therefore, Leidos Holdings has an ROCE of 11%.
Is Leidos Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Leidos Holdings's ROCE appears to be around the 9.7% average of the IT industry. Independently of how Leidos Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , Leidos Holdings currently has an ROCE of 11%, less than the 17% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Leidos Holdings's ROCE compares to its industry. Click to see more on 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Leidos Holdings.
Leidos Holdings's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Leidos Holdings has total assets of US$9.4b and current liabilities of US$2.3b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Leidos Holdings's ROCE
This is good to see, and with a sound ROCE, Leidos Holdings could be worth a closer look. Leidos Holdings 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 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.