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Here’s why Sangoma Technologies Corporation’s (CVE:STC) Returns On Capital Matters So Much

Today we'll look at Sangoma Technologies Corporation (CVE:STC) 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, 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.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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:

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

Or for Sangoma Technologies:

0.072 = CA$8.7m ÷ (CA$161m - CA$40m) (Based on the trailing twelve months to December 2019.)

So, Sangoma Technologies has an ROCE of 7.2%.

See our latest analysis for Sangoma Technologies

Does Sangoma Technologies Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Sangoma Technologies's ROCE appears meaningfully below the 11% average reported by the Communications industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Sangoma Technologies's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

In our analysis, Sangoma Technologies's ROCE appears to be 7.2%, compared to 3 years ago, when its ROCE was 5.5%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Sangoma Technologies's past growth compares to other companies.

TSXV:STC Past Revenue and Net Income May 22nd 2020
TSXV:STC Past Revenue and Net Income May 22nd 2020

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Sangoma Technologies.

Do Sangoma Technologies'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 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.

Sangoma Technologies has current liabilities of CA$40m and total assets of CA$161m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Sangoma Technologies's ROCE

If Sangoma Technologies continues to earn an uninspiring ROCE, there may be better places to invest. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.