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Are PC Connection, Inc.’s (NASDAQ:CNXN) High Returns Really That Great?

Jodi Pearce

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Today we are going to look at PC Connection, Inc. (NASDAQ:CNXN) 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.

First, we’ll go over how we calculate ROCE. 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.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 PC Connection:

0.16 = US$87m ÷ (US$805m – US$260m) (Based on the trailing twelve months to December 2018.)

So, PC Connection has an ROCE of 16%.

See our latest analysis for PC Connection

Does PC Connection Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that PC Connection’s ROCE is meaningfully better than the 11% average in the Electronic industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where PC Connection sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

NasdaqGS:CNXN Past Revenue and Net Income, February 20th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for PC Connection.

How PC Connection’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 counter this, investors can check if a company has high current liabilities relative to total assets.

PC Connection has total liabilities of US$260m and total assets of US$805m. Therefore its current liabilities are equivalent to approximately 32% of its total assets. With this level of current liabilities, PC Connection’s ROCE is boosted somewhat.

Our Take On PC Connection’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like PC Connection better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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. Thank you for reading.