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Why Information Services Group, Inc.’s (NASDAQ:III) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we are going to look at Information Services Group, Inc. (NASDAQ:III) to see whether it might be an attractive investment prospect. 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. 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Information Services Group:

0.06 = US$11m ÷ (US$217m - US$40m) (Based on the trailing twelve months to June 2019.)

Therefore, Information Services Group has an ROCE of 6.0%.

See our latest analysis for Information Services Group

Does Information Services Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Information Services Group's ROCE is meaningfully below the IT industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Information Services Group 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.

Information Services Group's current ROCE of 6.0% is lower than 3 years ago, when the company reported a 8.6% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Information Services Group's past growth compares to other companies.

NasdaqGM:III Past Revenue and Net Income, November 1st 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Information Services Group.

What Are Current Liabilities, And How Do They Affect Information Services Group's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Information Services Group has total assets of US$217m and current liabilities of US$40m. As a result, its current liabilities are equal to approximately 18% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From Information Services Group's ROCE

If Information Services Group continues to earn an uninspiring ROCE, there may be better places to invest. 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.

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 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.