Today we are going to look at IRadimed Corporation (NASDAQ:IRMD) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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’.
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 IRadimed:
0.14 = US$6.0m ÷ (US$48m – US$4.7m) (Based on the trailing twelve months to December 2018.)
Therefore, IRadimed has an ROCE of 14%.
Does IRadimed Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, IRadimed’s ROCE is meaningfully higher than the 11% 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 IRadimed sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
IRadimed’s current ROCE of 14% is lower than 3 years ago, when the company reported a 36% ROCE. This makes us wonder if the business is facing new challenges.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for IRadimed.
Do IRadimed’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
IRadimed has total assets of US$48m and current liabilities of US$4.7m. Therefore its current liabilities are equivalent to approximately 9.7% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), IRadimed earns a sound return on capital employed.
The Bottom Line On IRadimed’s ROCE
This is good to see, and while better prospects may exist, IRadimed seems worth researching further. There might be better investments than IRadimed 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.