Today we are going to look at Paychex, Inc. (NASDAQ:PAYX) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Paychex:
0.37 = US$1.4b ÷ (US$8.6b - US$4.8b) (Based on the trailing twelve months to August 2019.)
So, Paychex has an ROCE of 37%.
Does Paychex Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Paychex's ROCE appears to be substantially greater than the 11% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Paychex's ROCE is currently very good.
We can see that, Paychex currently has an ROCE of 37%, less than the 54% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Paychex'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Paychex.
How Paychex's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Paychex has total liabilities of US$4.8b and total assets of US$8.6b. As a result, its current liabilities are equal to approximately 56% of its total assets. Paychex boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On Paychex's ROCE
So to us, the company is potentially worth investigating further. There might be better investments than Paychex out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.