Should You Like Global Health Limited’s (ASX:GLH) High Return On Capital Employed?

Today we'll evaluate Global Health Limited (ASX:GLH) to determine whether it could have potential as an investment idea. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is 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. Ultimately, it is a useful but imperfect metric. 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 Global Health:

0.15 = AU$316k ÷ (AU$7.2m - AU$5.0m) (Based on the trailing twelve months to December 2018.)

So, Global Health has an ROCE of 15%.

Check out our latest analysis for Global Health

Does Global Health Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, Global Health's ROCE is meaningfully higher than the 11% average in the Healthcare Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Global Health sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. If Global Health is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Global Health'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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Global Health has total liabilities of AU$5.0m and total assets of AU$7.2m. As a result, its current liabilities are equal to approximately 70% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.

What We Can Learn From Global Health's ROCE

While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. Global Health 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.