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Why We’re Not Impressed By Micro Focus International plc’s (LON:MCRO) 4.2% ROCE

Bruce Howe

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Today we’ll evaluate Micro Focus International plc (LON:MCRO) to determine whether it could have potential as an investment idea. 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.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect 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. 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’.

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 Micro Focus International:

0.042 = US$609m ÷ (US$17b – US$2.4b) (Based on the trailing twelve months to October 2018.)

So, Micro Focus International has an ROCE of 4.2%.

See our latest analysis for Micro Focus International

Is Micro Focus International’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Micro Focus International’s ROCE is meaningfully below the Software industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Micro Focus International’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Micro Focus International’s current ROCE of 4.2% is lower than 3 years ago, when the company reported a 10% ROCE. So investors might consider if it has had issues recently.

LSE:MCRO Last Perf February 16th 19

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Micro Focus International’s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Micro Focus International has total liabilities of US$2.4b and total assets of US$17b. As a result, its current liabilities are equal to approximately 15% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Micro Focus International’s ROCE

That said, Micro Focus International’s ROCE is mediocre, there may be more attractive investments around. You might be able to find a better buy than Micro Focus International. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.