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Why We’re Not Keen On Quorum Information Technologies Inc.’s (CVE:QIS) 1.7% Return On Capital

Simply Wall St

Today we'll look at Quorum Information Technologies Inc. (CVE:QIS) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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. 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?

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 Quorum Information Technologies:

0.017 = CA$627k ÷ (CA$41m - CA$4.0m) (Based on the trailing twelve months to September 2019.)

Therefore, Quorum Information Technologies has an ROCE of 1.7%.

Check out our latest analysis for Quorum Information Technologies

Is Quorum Information Technologies's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Quorum Information Technologies's ROCE appears to be significantly below the 15% average in the Software industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Quorum Information Technologies's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

Quorum Information Technologies's current ROCE of 1.7% is lower than 3 years ago, when the company reported a 3.7% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Quorum Information Technologies's ROCE compares to its industry. Click to see more on past growth.

TSXV:QIS Past Revenue and Net Income, January 15th 2020

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

Do Quorum Information Technologies's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.

Quorum Information Technologies has total assets of CA$41m and current liabilities of CA$4.0m. As a result, its current liabilities are equal to approximately 9.7% of its total assets. Quorum Information Technologies has very few current liabilities, which have a minimal effect on its already low ROCE.

The Bottom Line On Quorum Information Technologies's ROCE

Nevertheless, there are potentially more attractive companies to invest in. You might be able to find a better investment than Quorum Information Technologies. 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).

I will like Quorum Information Technologies better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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. Thank you for reading.