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Here’s why Radware Ltd.’s (NASDAQ:RDWR) Returns On Capital Matters So Much

Simply Wall St

Today we'll look at Radware Ltd. (NASDAQ:RDWR) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is 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. Generally speaking a higher ROCE is better. 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?

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 Radware:

0.037 = US$17m ÷ (US$577m - US$125m) (Based on the trailing twelve months to June 2019.)

So, Radware has an ROCE of 3.7%.

Check out our latest analysis for Radware

Does Radware Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Radware's ROCE appears to be significantly below the 6.6% average in the Communications industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Radware'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.

Radware has an ROCE of 3.7%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can see in the image below how Radware's ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:RDWR Past Revenue and Net Income, September 13th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Radware.

What Are Current Liabilities, And How Do They Affect Radware's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.

Radware has total assets of US$577m and current liabilities of US$125m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Radware's ROCE

That's not a bad thing, however Radware has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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).

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 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. Thank you for reading.