Why Performant Financial Corporation’s (NASDAQ:PFMT) Return On Capital Employed Looks Uninspiring
Today we are going to look at Performant Financial Corporation (NASDAQ:PFMT) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to 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 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. 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 Performant Financial:
0.077 = -US$6.0m ÷ (US$142m – US$18m) (Based on the trailing twelve months to September 2018.)
So, Performant Financial has an ROCE of 7.7%.
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Is Performant Financial’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Performant Financial’s ROCE appears to be significantly below the 11% average in the Commercial Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Performant Financial’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.
As we can see, Performant Financial currently has an ROCE of 7.7% compared to its ROCE 3 years ago, which was 0.7%. This makes us think about whether the company has been reinvesting shrewdly.
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 Performant Financial.
What Are Current Liabilities, And How Do They Affect Performant Financial’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 counter this, investors can check if a company has high current liabilities relative to total assets.
Performant Financial has total liabilities of US$18m and total assets of US$142m. As a result, its current liabilities are equal to approximately 12% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Performant Financial’s ROCE
If Performant Financial continues to earn an uninspiring ROCE, there may be better places to invest. But note: Performant Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
