Today we’ll look at EDAP TMS S.A. (NASDAQ:EDAP) 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 up, we’ll look at what ROCE is and how we calculate it. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for EDAP TMS:
0.092 = €2.9m ÷ (€49m – €17m) (Based on the trailing twelve months to September 2019.)
So, EDAP TMS has an ROCE of 9.2%.
Does EDAP TMS Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, EDAP TMS’s ROCE appears to be around the 8.9% average of the Medical Equipment industry. Separate from how EDAP TMS stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Our data shows that EDAP TMS currently has an ROCE of 9.2%, compared to its ROCE of 7.2% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how EDAP TMS’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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for EDAP TMS.
How EDAP TMS’s Current Liabilities Impact Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
EDAP TMS has total liabilities of €17m and total assets of €49m. As a result, its current liabilities are equal to approximately 34% of its total assets. EDAP TMS has a medium level of current liabilities, which would boost its ROCE somewhat.
The Bottom Line On EDAP TMS’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than EDAP TMS. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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