Cardinal Health (NYSE:CAH) Shareholders Will Want The ROCE Trajectory To Continue

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Cardinal Health's (NYSE:CAH) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Cardinal Health is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.15 = US$1.6b ÷ (US$43b - US$33b) (Based on the trailing twelve months to March 2023).

So, Cardinal Health has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 9.7% it's much better.

View our latest analysis for Cardinal Health

Above you can see how the current ROCE for Cardinal Health compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cardinal Health.

What Does the ROCE Trend For Cardinal Health Tell Us?

You'd find it hard not to be impressed with the ROCE trend at Cardinal Health. The figures show that over the last five years, returns on capital have grown by 35%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 45% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 75% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Bottom Line

In the end, Cardinal Health has proven it's capital allocation skills are good with those higher returns from less amount of capital. Since the stock has returned a staggering 125% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One more thing, we've spotted 4 warning signs facing Cardinal Health that you might find interesting.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.