Today we'll look at Fair Isaac Corporation (NYSE:FICO) 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. 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?
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 Fair Isaac:
0.29 = US$262m ÷ (US$1.4b - US$458m) (Based on the trailing twelve months to June 2019.)
So, Fair Isaac has an ROCE of 29%.
Does Fair Isaac Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Fair Isaac's ROCE appears to be substantially greater than the 9.4% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Fair Isaac's ROCE currently appears to be excellent.
Our data shows that Fair Isaac currently has an ROCE of 29%, compared to its ROCE of 19% 3 years ago. This makes us wonder if the company is improving. You can see in the image below how Fair Isaac's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Fair Isaac.
Do Fair Isaac'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. 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.
Fair Isaac has total assets of US$1.4b and current liabilities of US$458m. Therefore its current liabilities are equivalent to approximately 33% of its total assets. Fair Isaac's ROCE is boosted somewhat by its middling amount of current liabilities.
The Bottom Line On Fair Isaac's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Fair Isaac looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.