Why We Like Varian Medical Systems, Inc.’s (NYSE:VAR) 23% Return On Capital Employed

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Today we’ll look at Varian Medical Systems, Inc. (NYSE:VAR) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 Varian Medical Systems:

0.23 = US$479m ÷ (US$3.4b – US$1.3b) (Based on the trailing twelve months to March 2019.)

So, Varian Medical Systems has an ROCE of 23%.

View our latest analysis for Varian Medical Systems

Does Varian Medical Systems Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Varian Medical Systems’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. Regardless of the industry comparison, in absolute terms, Varian Medical Systems’s ROCE currently appears to be excellent.

NYSE:VAR Past Revenue and Net Income, July 13th 2019
NYSE:VAR Past Revenue and Net Income, July 13th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Varian Medical Systems.

Varian Medical Systems’s Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Varian Medical Systems has total liabilities of US$1.3b and total assets of US$3.4b. As a result, its current liabilities are equal to approximately 39% of its total assets. Varian Medical Systems has a medium level of current liabilities, boosting its ROCE somewhat.

The Bottom Line On Varian Medical Systems’s ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than Varian Medical Systems 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.

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We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.