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Why You Should Care About Serko Limited’s (NZSE:SKO) Low Return On Capital

Simply Wall St

Today we'll look at Serko Limited (NZSE:SKO) 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.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

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 Serko:

0.047 = NZ$1.3m ÷ (NZ$33m - NZ$6.9m) (Based on the trailing twelve months to March 2019.)

Therefore, Serko has an ROCE of 4.7%.

Check out our latest analysis for Serko

Is Serko's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Serko's ROCE is meaningfully below the Software industry average of 16%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Serko stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

Serko delivered an ROCE of 4.7%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Serko's past growth compares to other companies.

NZSE:SKO Past Revenue and Net Income, August 31st 2019

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 Serko.

Serko's Current Liabilities And Their Impact On 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 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.

Serko has total assets of NZ$33m and current liabilities of NZ$6.9m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

Our Take On Serko's ROCE

That's not a bad thing, however Serko has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Serko. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Serko better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 editorial-team@simplywallst.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.