Why We Like Fisher & Paykel Healthcare Corporation Limited’s (NZSE:FPH) 30% Return On Capital Employed

Today we are going to look at Fisher & Paykel Healthcare Corporation Limited (NZSE:FPH) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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?

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 Fisher & Paykel Healthcare:

0.30 = NZ$312m ÷ (NZ$1.3b - NZ$200m) (Based on the trailing twelve months to September 2019.)

Therefore, Fisher & Paykel Healthcare has an ROCE of 30%.

Check out our latest analysis for Fisher & Paykel Healthcare

Does Fisher & Paykel Healthcare Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Fisher & Paykel Healthcare's ROCE is meaningfully higher than the 13% 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. Putting aside its position relative to its industry for now, in absolute terms, Fisher & Paykel Healthcare's ROCE is currently very good.

The image below shows how Fisher & Paykel Healthcare's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Fisher & Paykel Healthcare's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Fisher & Paykel Healthcare has total assets of NZ$1.3b and current liabilities of NZ$200m. As a result, its current liabilities are equal to approximately 16% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.

The Bottom Line On Fisher & Paykel Healthcare's ROCE

This is good to see, and with such a high ROCE, Fisher & Paykel Healthcare may be worth a closer look. There might be better investments than Fisher & Paykel Healthcare out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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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.