Here’s why Cardiovascular Systems, Inc.’s (NASDAQ:CSII) Returns On Capital Matters So Much

Today we'll look at Cardiovascular Systems, Inc. (NASDAQ:CSII) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?

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 Cardiovascular Systems:

0.0099 = US$1.7m ÷ (US$211m - US$40m) (Based on the trailing twelve months to March 2019.)

Therefore, Cardiovascular Systems has an ROCE of 1.0%.

Check out our latest analysis for Cardiovascular Systems

Does Cardiovascular Systems Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Cardiovascular Systems's ROCE is meaningfully below the Medical Equipment industry average of 10%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Cardiovascular Systems stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

Cardiovascular Systems delivered an ROCE of 1.0%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Cardiovascular Systems.

Do Cardiovascular Systems'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Cardiovascular Systems has total assets of US$211m and current liabilities of US$40m. As a result, its current liabilities are equal to approximately 19% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

Our Take On Cardiovascular Systems's ROCE

Cardiovascular Systems has a poor ROCE, and there may be better investment prospects out there. 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.