Today we’ll look at Atrion Corporation (NASDAQ:ATRI) 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
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. In brief, it is a useful tool, but it is not without drawbacks. 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 Atrion:
0.17 = US$41m ÷ (US$257m – US$11m) (Based on the trailing twelve months to September 2019.)
Therefore, Atrion has an ROCE of 17%.
Is Atrion’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Atrion’s ROCE is meaningfully better than the 8.9% average in the Medical Equipment industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Atrion compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Atrion currently has an ROCE of 17%, less than the 23% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Atrion’s ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. If Atrion is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Atrion’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Atrion has total assets of US$257m and current liabilities of US$11m. Therefore its current liabilities are equivalent to approximately 4.4% of its total assets. Low current liabilities have only a minimal impact on Atrion’s ROCE, making its decent returns more credible.
What We Can Learn From Atrion’s ROCE
If Atrion can continue reinvesting in its business, it could be an attractive prospect. Atrion 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.
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 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.
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