Today we’ll evaluate Tivity Health, Inc. (NASDAQ:TVTY) to determine whether it could have potential as an investment idea. 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. And finally, we’ll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Tivity Health:
0.089 = US$165m ÷ (US$2.0b – US$159m) (Based on the trailing twelve months to June 2019.)
So, Tivity Health has an ROCE of 8.9%.
Is Tivity Health’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Tivity Health’s ROCE is around the 11% average reported by the Healthcare industry. Setting aside the industry comparison for now, Tivity Health’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Tivity Health’s current ROCE of 8.9% is lower than its ROCE in the past, which was 29%, 3 years ago. Therefore we wonder if the company is facing new headwinds. Take a look at the image below to see how Tivity Health’s past growth compares to the average in its industry.
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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Tivity 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 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.
Tivity Health has total liabilities of US$159m and total assets of US$2.0b. Therefore its current liabilities are equivalent to approximately 7.9% of its total assets. Tivity Health reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Tivity Health’s ROCE
Based on this information, Tivity Health appears to be a mediocre business. Of course, you might also be able to find a better stock than Tivity Health. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.