This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Medtronic plc (NYSE:MDT)’s return fundamentals and stock market performance.
Purchasing Medtronic gives you an ownership stake in the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in Medtronic, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
ROCE: Explanation and Calculation
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We’ll look at Medtronic’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:
ROCE Calculation for MDT
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$5.78b ÷ (US$91.39b – US$10.08b) = 7.11%
MDT’s 7.11% ROCE means that for every $100 you invest, the company creates $7.1. A good ROCE hurdle you should aim for in your investments is 15%, which MDT has failed to reach, meaning the company creates an unimpressive amount of earnings from capital employed.
A deeper look
The underperforming ROCE is not ideal for Medtronic investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, MDT’s ROCE may increase, in which case your portfolio could benefit from holding the company. Because of this, it is important to look beyond the final value of MDT’s ROCE and understand what is happening to the individual components. Three years ago, MDT’s ROCE was 5.02%, which means the company’s capital returns have improved. Similarly, the movement in the earnings variable shows a jump from US$4.89b to US$5.78b whilst the amount of capital employed has deteriorated due to a decreased level of total assets and increase in current liabilities (more borrowed money) , which means the company has been able to improve ROCE by growing earnings and simultaneously putting less capital to work.
Despite MDT’s current ROCE remains at an unattractive level, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation to determine if an opportunity exists that isn’t made apparent by looking at past data. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate MDT or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for MDT’s future growth? Take a look at our free research report of analyst consensus for MDT’s outlook.
- Valuation: What is MDT worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether MDT is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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 email@example.com.