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What Can We Make Of Cadence Design Systems, Inc.’s (NASDAQ:CDNS) High Return On Capital?

Today we’ll evaluate Cadence Design Systems, Inc. (NASDAQ:CDNS) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we’ll go over how we calculate ROCE. 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.

Return On Capital Employed (ROCE): What is it?

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. Overall, it is a valuable metric that has its flaws. 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’.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Cadence Design Systems:

0.22 = US$333m ÷ (US$2.3b – US$541m) (Based on the trailing twelve months to September 2018.)

So, Cadence Design Systems has an ROCE of 22%.

Check out our latest analysis for Cadence Design Systems

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Does Cadence Design Systems Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Cadence Design Systems’s ROCE is meaningfully better than the 9.5% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Cadence Design Systems’s ROCE is currently very good.

Our data shows that Cadence Design Systems currently has an ROCE of 22%, compared to its ROCE of 15% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

NASDAQGS:CDNS Last Perf January 29th 19
NASDAQGS:CDNS Last Perf January 29th 19

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Cadence Design Systems.

What Are Current Liabilities, And How Do They Affect Cadence Design Systems’s ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Cadence Design Systems has total assets of US$2.3b and current liabilities of US$541m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.

Our Take On Cadence Design Systems’s ROCE

This is good to see, and with such a high ROCE, Cadence Design Systems may be worth a closer look. You might be able to find a better buy than Cadence Design Systems. 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).

I will like Cadence Design Systems better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.