Today we’ll evaluate salesforce.com, inc. (NYSE:CRM) to determine whether it could have potential as an investment idea. 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. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 salesforce.com:
0.029 = US$562m ÷ (US$31b – US$11b) (Based on the trailing twelve months to January 2019.)
So, salesforce.com has an ROCE of 2.9%.
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Does salesforce.com Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, salesforce.com’s ROCE appears meaningfully below the 9.4% average reported by the Software industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how salesforce.com compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.
In our analysis, salesforce.com’s ROCE appears to be 2.9%, compared to 3 years ago, when its ROCE was 1.1%. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do salesforce.com’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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
salesforce.com has total assets of US$31b and current liabilities of US$11b. Therefore its current liabilities are equivalent to approximately 37% of its total assets. With a medium level of current liabilities boosting the ROCE a little, salesforce.com’s low ROCE is unappealing.
The Bottom Line On salesforce.com’s ROCE
There are likely better investments out there. Of course you might be able to find a better stock than salesforce.com. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like salesforce.com better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.