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Here’s why Sogou Inc.’s (NYSE:SOGO) Returns On Capital Matters So Much

Simply Wall St

Today we'll look at Sogou Inc. (NYSE:SOGO) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. 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?

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 Sogou:

0.005 = US$5.2m ÷ (US$1.5b - US$492m) (Based on the trailing twelve months to June 2019.)

So, Sogou has an ROCE of 0.5%.

View our latest analysis for Sogou

Does Sogou Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Sogou's ROCE appears to be significantly below the 9.1% average in the Interactive Media and Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Sogou compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.

We can see that , Sogou currently has an ROCE of 0.5%, less than the 62% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Sogou's ROCE compares to its industry. Click to see more on past growth.

NYSE:SOGO Past Revenue and Net Income, August 22nd 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Sogou.

What Are Current Liabilities, And How Do They Affect Sogou'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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Sogou has total liabilities of US$492m and total assets of US$1.5b. As a result, its current liabilities are equal to approximately 32% of its total assets. Sogou has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.

The Bottom Line On Sogou's ROCE

So researching other companies may be a better use of your time. You might be able to find a better investment than Sogou. 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).

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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.