Today we’ll look at ResMed Inc. (NYSE:RMD) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 ResMed:
0.18 = US$697m ÷ (US$4.4b – US$500m) (Based on the trailing twelve months to December 2019.)
Therefore, ResMed has an ROCE of 18%.
Does ResMed Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. ResMed’s ROCE appears to be substantially greater than the 9.2% 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. Regardless of where ResMed sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how ResMed’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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for ResMed.
ResMed’s Current Liabilities And Their Impact On 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.
ResMed has total assets of US$4.4b and current liabilities of US$500m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On ResMed’s ROCE
With that in mind, ResMed’s ROCE appears pretty good. There might be better investments than ResMed 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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