Today we’ll look at Utah Medical Products, Inc. (NASDAQ:UTMD) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
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.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. 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?
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$100m – US$5.3m) (Based on the trailing twelve months to December 2018.)
Therefore, Utah Medical Products has an ROCE of 20%.
Is Utah Medical Products’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Utah Medical Products’s ROCE is meaningfully better than the 11% average in the Medical Equipment industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Utah Medical Products’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
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. How cyclical is Utah Medical Products? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Utah Medical Products’s Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Utah Medical Products has total assets of US$100m and current liabilities of US$5.3m. Therefore its current liabilities are equivalent to approximately 5.3% of its total assets. With low current liabilities, Utah Medical Products’s decent ROCE looks that much more respectable.
The Bottom Line On Utah Medical Products’s ROCE
If it is able to keep this up, Utah Medical Products could be attractive. But note: Utah Medical Products may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.