Today we’ll evaluate Stryker Corporation (NYSE:SYK) 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.
Return On Capital Employed (ROCE): What is it?
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. 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 Stryker:
0.13 = US$3.4b ÷ (US$29b – US$4.2b) (Based on the trailing twelve months to March 2020.)
Therefore, Stryker has an ROCE of 13%.
Is Stryker’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Stryker’s ROCE is meaningfully better than the 10.0% average in the Medical Equipment industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Stryker’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how Stryker’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Stryker.
What Are Current Liabilities, And How Do They Affect Stryker’s 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.
Stryker has current liabilities of US$4.2b and total assets of US$29b. As a result, its current liabilities are equal to approximately 14% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Stryker’s ROCE
This is good to see, and with a sound ROCE, Stryker could be worth a closer look. Stryker 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.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.