Today we'll look at Changyou.com Limited (NASDAQ:CYOU) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. 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?
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 Changyou.com:
0.22 = US$108m ÷ (US$1.8b - US$1.3b) (Based on the trailing twelve months to June 2019.)
So, Changyou.com has an ROCE of 22%.
Is Changyou.com's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Changyou.com's ROCE appears to be substantially greater than the 8.2% average in the Entertainment 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. Regardless of the industry comparison, in absolute terms, Changyou.com's ROCE currently appears to be excellent.
We can see that , Changyou.com currently has an ROCE of 22% compared to its ROCE 3 years ago, which was 15%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Changyou.com's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Changyou.com.
Changyou.com's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
Changyou.com has total liabilities of US$1.3b and total assets of US$1.8b. Therefore its current liabilities are equivalent to approximately 73% of its total assets. Changyou.com boasts an attractive ROCE, even after considering the boost from high current liabilities.
Our Take On Changyou.com's ROCE
So to us, the company is potentially worth investigating further. Changyou.com looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.