Today we'll look at TechTarget, Inc. (NASDAQ:TTGT) 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. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 TechTarget:
0.10 = US$17m ÷ (US$176m - US$15m) (Based on the trailing twelve months to December 2018.)
Therefore, TechTarget has an ROCE of 10%.
Does TechTarget Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, TechTarget's ROCE appears to be around the 9.1% average of the Media industry. Aside from the industry comparison, TechTarget's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
In our analysis, TechTarget's ROCE appears to be 10%, compared to 3 years ago, when its ROCE was 7.5%. This makes us think the business might be improving.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for TechTarget.
How TechTarget's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
TechTarget has total liabilities of US$15m and total assets of US$176m. Therefore its current liabilities are equivalent to approximately 8.2% of its total assets. With low levels of current liabilities, at least TechTarget's mediocre ROCE is not unduly boosted.
What We Can Learn From TechTarget's ROCE
TechTarget looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than TechTarget. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.