Today we are going to look at Inspirisys Solutions Limited (NSE:INSPIRISYS) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Inspirisys Solutions:
0.22 = ₹195m ÷ (₹3.4b - ₹2.5b) (Based on the trailing twelve months to September 2019.)
Therefore, Inspirisys Solutions has an ROCE of 22%.
Does Inspirisys Solutions Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Inspirisys Solutions's ROCE is meaningfully better than the 14% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Inspirisys Solutions sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Inspirisys Solutions currently has an ROCE of 22%, less than the 41% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Inspirisys Solutions'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, after all, simply a snap shot of a single year. You can check if Inspirisys Solutions has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Inspirisys Solutions's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
Inspirisys Solutions has total liabilities of ₹2.5b and total assets of ₹3.4b. As a result, its current liabilities are equal to approximately 74% of its total assets. Inspirisys Solutions's current liabilities are fairly high, which increases its ROCE significantly.
The Bottom Line On Inspirisys Solutions's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Inspirisys Solutions shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Inspirisys Solutions better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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