Today we are going to look at Mesa Laboratories, Inc. (NASDAQ:MLAB) 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
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 Mesa Laboratories:
0.13 = US$18m ÷ (US$160m – US$21m) (Based on the trailing twelve months to June 2019.)
Therefore, Mesa Laboratories has an ROCE of 13%.
Does Mesa Laboratories Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Mesa Laboratories’s ROCE is meaningfully higher than the 10.0% average in the Medical Equipment industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Mesa Laboratories’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how Mesa Laboratories’s past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 Mesa Laboratories.
Do Mesa Laboratories’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Mesa Laboratories has total liabilities of US$21m and total assets of US$160m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Mesa Laboratories’s ROCE
This is good to see, and with a sound ROCE, Mesa Laboratories could be worth a closer look. Mesa Laboratories 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.
I will like Mesa Laboratories 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 firstname.lastname@example.org. 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.