Today we’ll evaluate Utah Medical Products, Inc. (NASDAQ:UTMD) to determine whether it could have potential as an investment idea. 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.
First of all, we’ll work out how to 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 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. 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.
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 Utah Medical Products:
0.17 = US$18m ÷ (US$110m – US$3.4m) (Based on the trailing twelve months to December 2019.)
Therefore, Utah Medical Products has an ROCE of 17%.
Does Utah Medical Products Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Utah Medical Products’s ROCE appears to be substantially greater than the 9.4% 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 Utah Medical Products’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Utah Medical Products’s current ROCE of 17% is lower than its ROCE in the past, which was 22%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Utah Medical Products’s past growth compares to other companies.
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. You can check if Utah Medical Products has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Utah Medical Products’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 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.
Utah Medical Products has current liabilities of US$3.4m and total assets of US$110m. Therefore its current liabilities are equivalent to approximately 3.1% of its total assets. Low current liabilities have only a minimal impact on Utah Medical Products’s ROCE, making its decent returns more credible.
What We Can Learn From Utah Medical Products’s ROCE
If Utah Medical Products can continue reinvesting in its business, it could be an attractive prospect. Utah Medical Products 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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