Today we’ll evaluate Utah Medical Products, Inc. (NASDAQ:UTMD) 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. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, ROCE 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 Utah Medical Products:
0.20 = US$19m ÷ (US$99m – US$4.8m) (Based on the trailing twelve months to September 2018.)
Therefore, Utah Medical Products has an ROCE of 20%.
Does Utah Medical Products Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Utah Medical Products’s ROCE appears to be substantially greater 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. Independently of how Utah Medical Products compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Utah Medical Products is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Utah Medical Products’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.
Utah Medical Products has total assets of US$99m and current liabilities of US$4.8m. Therefore its current liabilities are equivalent to approximately 4.8% of its total assets.
The Bottom Line On Utah Medical Products’s ROCE
In addition to low current liabilities (making a negligible impact on ROCE), Utah Medical Products earns a sound return on capital employed. If Utah Medical Products can continue reinvesting in its business, it could be an attractive prospect. While the ROCE is useful information, it is not always predictive. We need to do more work before making a decision. For example you might check if insiders are buying shares.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.
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.