Today we’ll evaluate American Renal Associates Holdings, Inc. (NYSE:ARA) 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for American Renal Associates Holdings:
0.17 = US$123m ÷ (US$967m – US$179m) (Based on the trailing twelve months to September 2018.)
So, American Renal Associates Holdings has an ROCE of 17%.
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Does American Renal Associates Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, American Renal Associates Holdings’s ROCE is meaningfully higher than the 13% average in the Healthcare industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how American Renal Associates Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How American Renal Associates Holdings’s Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.
American Renal Associates Holdings has total assets of US$967m and current liabilities of US$179m. As a result, its current liabilities are equal to approximately 19% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On American Renal Associates Holdings’s ROCE
Overall, American Renal Associates Holdings has a decent ROCE and could be worthy of further research. You might be able to find a better buy than American Renal Associates Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 firstname.lastname@example.org.