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Today we'll evaluate ExlService Holdings, Inc. (NASDAQ:EXLS) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 ExlService Holdings:
0.072 = US$74m ÷ (US$1.2b - US$158m) (Based on the trailing twelve months to March 2019.)
So, ExlService Holdings has an ROCE of 7.2%.
Is ExlService Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, ExlService Holdings's ROCE appears meaningfully below the 10% average reported by the IT industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how ExlService Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
ExlService Holdings's current ROCE of 7.2% is lower than 3 years ago, when the company reported a 13% ROCE. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 ExlService Holdings.
What Are Current Liabilities, And How Do They Affect ExlService Holdings's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
ExlService Holdings has total liabilities of US$158m and total assets of US$1.2b. As a result, its current liabilities are equal to approximately 13% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On ExlService Holdings's ROCE
If ExlService Holdings continues to earn an uninspiring ROCE, there may be better places to invest. 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.
I will like ExlService Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 email@example.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.