Today we’ll evaluate Sylogist Ltd. (CVE:SYZ) to determine whether it could have potential as an investment idea. 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.
First of all, we’ll work out how to 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 measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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’.
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 Sylogist:
0.26 = CA$12m ÷ (CA$61m – CA$15m) (Based on the trailing twelve months to September 2018.)
Therefore, Sylogist has an ROCE of 26%.
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Is Sylogist’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Sylogist’s ROCE is meaningfully better than the 11% average in the IT 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. Putting aside its position relative to its industry for now, in absolute terms, Sylogist’s ROCE is currently very good.
As we can see, Sylogist currently has an ROCE of 26% compared to its ROCE 3 years ago, which was 2.1%. This makes us think about whether the company has been reinvesting shrewdly.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Sylogist’s Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Sylogist has total liabilities of CA$15m and total assets of CA$61m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On Sylogist’s ROCE
Low current liabilities and high ROCE is a good combination, making Sylogist look quite interesting. But note: Sylogist may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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.