Here’s why Hansen Technologies Ltd’s (ASX:HSN) Returns On Capital Matters So Much
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Today we’ll evaluate Hansen Technologies Ltd (ASX:HSN) 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 up, we’ll look at what ROCE is and how we calculate it. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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.’
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 Hansen Technologies:
0.12 = AU$40m ÷ (AU$331m – AU$51m) (Based on the trailing twelve months to December 2018.)
So, Hansen Technologies has an ROCE of 12%.
See our latest analysis for Hansen Technologies
Is Hansen Technologies’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Hansen Technologies’s ROCE is meaningfully below the Software industry average of 20%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Hansen Technologies compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Hansen Technologies’s current ROCE of 12% is lower than its ROCE in the past, which was 23%, 3 years ago. This makes us wonder if the business is facing new challenges.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Hansen Technologies.
What Are Current Liabilities, And How Do They Affect Hansen Technologies’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 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.
Hansen Technologies has total assets of AU$331m and current liabilities of AU$51m. As a result, its current liabilities are equal to approximately 16% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Hansen Technologies’s ROCE
This is good to see, and with a sound ROCE, Hansen Technologies could be worth a closer look. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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.
