Should You Worry About Cirrus Networks Holdings Limited’s (ASX:CNW) ROCE?
Today we'll look at Cirrus Networks Holdings Limited (ASX:CNW) 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, we'll go over how we 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.
Understanding 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Cirrus Networks Holdings:
0.075 = AU$978k ÷ (AU$32m - AU$19m) (Based on the trailing twelve months to December 2019.)
Therefore, Cirrus Networks Holdings has an ROCE of 7.5%.
View our latest analysis for Cirrus Networks Holdings
Is Cirrus Networks Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Cirrus Networks Holdings's ROCE appears to be significantly below the 12% average in the IT industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Cirrus Networks Holdings'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.
Cirrus Networks Holdings reported an ROCE of 7.5% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how Cirrus Networks Holdings'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. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Cirrus Networks Holdings's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Cirrus Networks Holdings has total assets of AU$32m and current liabilities of AU$19m. Therefore its current liabilities are equivalent to approximately 59% of its total assets. With a high level of current liabilities, Cirrus Networks Holdings will experience a boost to its ROCE.
Our Take On Cirrus Networks Holdings's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might also be able to find a better stock than Cirrus Networks Holdings. 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).
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.
