The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Primary Health Care Limited (ASX:PRY)’s return fundamentals and stock market performance.
Buying Primary Health Care makes you a partial owner of the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. Your return is tied to PRY’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Thus, to understand how your money can grow by investing in Primary Health Care, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
Calculating Return On Capital Employed for PRY
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We’ll look at Primary Health Care’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated Primary Health Care’s ROCE for you below:
ROCE Calculation for PRY
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$78.30m ÷ (AU$3.10b – AU$321.80m) = 2.82%
As you can see, PRY earned A$2.8 from every A$100 you invested over the previous twelve months. A good ROCE hurdle you should aim for in your investments is 15%, which PRY has missed by a wide margin, meaning the company creates a poor amount of earnings from capital employed.
What is causing this?
PRY doesn’t return an attractive amount on capital, but this will only continue if the company is unable to increase earnings or decrease current capital requirements. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Three years ago, PRY’s ROCE was 5.16%, which means the company’s capital returns have worsened. In this time, earnings have fallen from AU$182.14m to AU$78.30m and capital employed also decreased but to a smaller extent, which means the company’s ROCE has deteriorated due to a decline in earnings relative to the capital invested in the business.
Primary Health Care’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. However, it is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for PRY’s future growth? Take a look at our free research report of analyst consensus for PRY’s outlook.
- Valuation: What is PRY worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether PRY is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.