Today we'll evaluate ScanSource, Inc. (NASDAQ:SCSC) 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.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. In brief, it is a useful tool, but it is not without drawbacks. 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 ScanSource:
0.078 = US$106m ÷ (US$2.1b - US$701m) (Based on the trailing twelve months to June 2019.)
Therefore, ScanSource has an ROCE of 7.8%.
Does ScanSource Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see ScanSource's ROCE is meaningfully below the Electronic 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, ScanSource's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
ScanSource's current ROCE of 7.8% is lower than its ROCE in the past, which was 11%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how ScanSource's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 ScanSource.
ScanSource's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
ScanSource has total assets of US$2.1b and current liabilities of US$701m. Therefore its current liabilities are equivalent to approximately 34% of its total assets. ScanSource's ROCE is improved somewhat by its moderate amount of current liabilities.
What We Can Learn From ScanSource's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than ScanSource. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.