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Today we are going to look at ResMed Inc. (NYSE:RMD) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it 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 ResMed:
0.17 = US$619m ÷ (US$4.1b - US$463m) (Based on the trailing twelve months to March 2019.)
Therefore, ResMed has an ROCE of 17%.
Is ResMed's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that ResMed's ROCE is meaningfully better than the 10% average in the Medical Equipment industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where ResMed sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for ResMed.
What Are Current Liabilities, And How Do They Affect ResMed's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
ResMed has total liabilities of US$463m and total assets of US$4.1b. Therefore its current liabilities are equivalent to approximately 11% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On ResMed's ROCE
This is good to see, and with a sound ROCE, ResMed could be worth a closer look. There might be better investments than ResMed out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.