Today we'll evaluate Align Technology, Inc. (NASDAQ:ALGN) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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'.
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 Align Technology:
0.31 = US$489m ÷ (US$2.3b - US$789m) (Based on the trailing twelve months to June 2019.)
So, Align Technology has an ROCE of 31%.
Is Align Technology's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Align Technology's ROCE is meaningfully higher than the 10.0% average in the Medical Equipment industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Align Technology's ROCE currently appears to be excellent.
In our analysis, Align Technology's ROCE appears to be 31%, compared to 3 years ago, when its ROCE was 23%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Align Technology's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Align Technology'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 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.
Align Technology has total assets of US$2.3b and current liabilities of US$789m. As a result, its current liabilities are equal to approximately 34% of its total assets. Align Technology's ROCE is boosted somewhat by its middling amount of current liabilities.
Our Take On Align Technology's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than Align Technology 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.
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.