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Today we’ll evaluate Qualstar Corporation (NASDAQ:QBAK) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting 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. 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.’
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 Qualstar:
0.29 = US$657k ÷ (US$10m – US$2.6m) (Based on the trailing twelve months to September 2018.)
Therefore, Qualstar has an ROCE of 29%.
Is Qualstar’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Qualstar’s ROCE is meaningfully higher than the 12% average in the Tech 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, Qualstar’s ROCE is currently very good.
Qualstar reported an ROCE of 29% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. How cyclical is Qualstar? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Qualstar’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Qualstar has total assets of US$10m and current liabilities of US$2.6m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On Qualstar’s ROCE
With low current liabilities and a high ROCE, Qualstar could be worthy of further investigation. Of course you might be able to find a better stock than Qualstar. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Qualstar better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.