Today we’ll look at Datalex plc (ISE:DLE) 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.’
How Do You Calculate Return On Capital Employed?
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 Datalex:
0.15 = US$7.2m ÷ (US$71m – US$24m) (Based on the trailing twelve months to June 2018.)
So, Datalex has an ROCE of 15%.
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Is Datalex’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Datalex’s ROCE is meaningfully higher than the 12% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Datalex compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, Datalex currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 9.9%. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Datalex.
How Datalex’s Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.