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Today we'll evaluate Take-Two Interactive Software, Inc. (NASDAQ:TTWO) 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 of all, we'll work out how to 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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.'
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 Take-Two Interactive Software:
0.091 = US$209m ÷ (US$4.2b - US$2.0b) (Based on the trailing twelve months to March 2019.)
So, Take-Two Interactive Software has an ROCE of 9.1%.
Does Take-Two Interactive Software Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Take-Two Interactive Software's ROCE is around the 9.8% average reported by the Entertainment industry. Separate from how Take-Two Interactive Software stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
As we can see, Take-Two Interactive Software currently has an ROCE of 9.1% compared to its ROCE 3 years ago, which was 6.1%. 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Take-Two Interactive Software.
What Are Current Liabilities, And How Do They Affect Take-Two Interactive Software's 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Take-Two Interactive Software has total assets of US$4.2b and current liabilities of US$2.0b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Take-Two Interactive Software's middling level of current liabilities have the effect of boosting its ROCE a bit.
Our Take On Take-Two Interactive Software's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 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.