Today we’ll look at IRadimed Corporation (NASDAQ:IRMD) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, 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 amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 IRadimed:
0.14 = US$7.1m ÷ (US$57m – US$4.9m) (Based on the trailing twelve months to June 2019.)
So, IRadimed has an ROCE of 14%.
Does IRadimed Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, IRadimed’s ROCE is meaningfully higher than the 10% 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 IRadimed’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
IRadimed’s current ROCE of 14% is lower than 3 years ago, when the company reported a 45% ROCE. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is 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 IRadimed.
Do IRadimed’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
IRadimed has total liabilities of US$4.9m and total assets of US$57m. As a result, its current liabilities are equal to approximately 8.5% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), IRadimed earns a sound return on capital employed.
Our Take On IRadimed’s ROCE
If it is able to keep this up, IRadimed could be attractive. IRadimed shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like IRadimed better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.