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Today we'll look at JCurve Solutions Limited (ASX:JCS) and reflect on its potential as an investment. 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. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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'.
How Do You Calculate Return On Capital Employed?
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 JCurve Solutions:
0.086 = AU$500k ÷ (AU$11m - AU$4.8m) (Based on the trailing twelve months to December 2018.)
So, JCurve Solutions has an ROCE of 8.6%.
See our latest analysis for JCurve Solutions
Is JCurve Solutions's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see JCurve Solutions's ROCE is meaningfully below the Software industry average of 19%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, JCurve Solutions's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
JCurve Solutions delivered an ROCE of 8.6%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if JCurve Solutions has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.