Why We Like Advanced Medical Solutions Group plc’s (LON:AMS) 14% Return On Capital Employed

Today we’ll evaluate Advanced Medical Solutions Group plc (LON:AMS) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

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. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.

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 Advanced Medical Solutions Group:

0.14 = UK£27m ÷ (UK£215m – UK£14m) (Based on the trailing twelve months to June 2019.)

So, Advanced Medical Solutions Group has an ROCE of 14%.

View our latest analysis for Advanced Medical Solutions Group

Is Advanced Medical Solutions Group’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Advanced Medical Solutions Group’s ROCE appears to be substantially greater than the 8.9% 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 where Advanced Medical Solutions Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can click on the image below to see (in greater detail) how Advanced Medical Solutions Group’s past growth compares to other companies.

AIM:AMS Past Revenue and Net Income, February 21st 2020
AIM:AMS Past Revenue and Net Income, February 21st 2020

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Advanced Medical Solutions Group.

What Are Current Liabilities, And How Do They Affect Advanced Medical Solutions Group’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Advanced Medical Solutions Group has total assets of UK£215m and current liabilities of UK£14m. Therefore its current liabilities are equivalent to approximately 6.7% of its total assets. Low current liabilities have only a minimal impact on Advanced Medical Solutions Group’s ROCE, making its decent returns more credible.

What We Can Learn From Advanced Medical Solutions Group’s ROCE

If it is able to keep this up, Advanced Medical Solutions Group could be attractive. There might be better investments than Advanced Medical Solutions Group 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.

I will like Advanced Medical Solutions Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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