Today we are going to look at NIC Inc. (NASDAQ:EGOV) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.
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 NIC:
0.27 = US$68m ÷ (US$365m - US$116m) (Based on the trailing twelve months to June 2019.)
So, NIC has an ROCE of 27%.
Does NIC Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. NIC's ROCE appears to be substantially greater than the 9.5% average in the IT industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, NIC's ROCE is currently very good.
We can see that , NIC currently has an ROCE of 27%, less than the 50% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how NIC's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for NIC.
What Are Current Liabilities, And How Do They Affect NIC's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
NIC has total assets of US$365m and current liabilities of US$116m. Therefore its current liabilities are equivalent to approximately 32% of its total assets. A medium level of current liabilities boosts NIC's ROCE somewhat.
What We Can Learn From NIC's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than NIC out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like NIC better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.