Is Magic Software Enterprises Ltd.’s (NASDAQ:MGIC) Return On Capital Employed Any Good?
Today we'll look at Magic Software Enterprises Ltd. (NASDAQ:MGIC) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Magic Software Enterprises:
0.098 = US$33m ÷ (US$401m - US$63m) (Based on the trailing twelve months to September 2019.)
So, Magic Software Enterprises has an ROCE of 9.8%.
View our latest analysis for Magic Software Enterprises
Is Magic Software Enterprises's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Magic Software Enterprises's ROCE appears to be around the 9.8% average of the Software industry. Regardless of where Magic Software Enterprises sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
The image below shows how Magic Software Enterprises's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Magic Software Enterprises.
Magic Software Enterprises's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.
Magic Software Enterprises has current liabilities of US$63m and total assets of US$401m. As a result, its current liabilities are equal to approximately 16% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Magic Software Enterprises's ROCE
Overall, Magic Software Enterprises has a decent ROCE and could be worthy of further research. Magic Software Enterprises looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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. Thank you for reading.
