Today we'll look at DASAN Zhone Solutions, Inc. (NASDAQ:DZSI) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. 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'.
How Do You Calculate Return On Capital Employed?
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 DASAN Zhone Solutions:
0.042 = US$7.8m ÷ (US$280m - US$93m) (Based on the trailing twelve months to June 2019.)
So, DASAN Zhone Solutions has an ROCE of 4.2%.
Does DASAN Zhone Solutions Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, DASAN Zhone Solutions's ROCE appears meaningfully below the 6.6% average reported by the Communications industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how DASAN Zhone Solutions compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
DASAN Zhone Solutions reported an ROCE of 4.2% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how DASAN Zhone Solutions's ROCE compares to its industry. Click to see more on past growth.
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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do DASAN Zhone Solutions's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
DASAN Zhone Solutions has total liabilities of US$93m and total assets of US$280m. As a result, its current liabilities are equal to approximately 33% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, DASAN Zhone Solutions's ROCE is concerning.
The Bottom Line On DASAN Zhone Solutions's ROCE
So researching other companies may be a better use of your time. Of course, you might also be able to find a better stock than DASAN Zhone Solutions. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.