Today we’ll look at AirIQ Inc. (CVE:IQ) 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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. 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 AirIQ:
0.21 = CA$280k ÷ (CA$2.3m – CA$755k) (Based on the trailing twelve months to September 2018.)
Therefore, AirIQ has an ROCE of 21%.
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Does AirIQ Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that AirIQ’s ROCE is meaningfully better than the 9.0% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, AirIQ’s ROCE in absolute terms currently looks quite high.
AirIQ’s current ROCE of 21% is lower than 3 years ago, when the company reported a 40% ROCE. So investors might consider if it has had issues recently.
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. If AirIQ is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do AirIQ’s Current Liabilities Skew 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
AirIQ has total assets of CA$2.3m and current liabilities of CA$755k. Therefore its current liabilities are equivalent to approximately 33% of its total assets. A medium level of current liabilities boosts AirIQ’s ROCE somewhat.
Our Take On AirIQ’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 email@example.com.