Today we'll look at Progress Software Corporation (NASDAQ:PRGS) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Progress Software:
0.14 = US$88m ÷ (US$830m - US$204m) (Based on the trailing twelve months to May 2019.)
So, Progress Software has an ROCE of 14%.
Is Progress Software's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Progress Software's ROCE is meaningfully higher than the 9.5% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Progress Software sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that , Progress Software currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 9.0%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Progress Software's past growth compares to other companies.
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. 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 Progress Software.
Do Progress Software's Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Progress Software has total liabilities of US$204m and total assets of US$830m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Progress Software's ROCE
With that in mind, Progress Software's ROCE appears pretty good. There might be better investments than Progress Software 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.
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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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.