Today we’ll look at AmerisourceBergen Corporation (NYSE:ABC) and reflect on its potential as an investment. 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. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 AmerisourceBergen:
0.16 = US$1.6b ÷ (US$39b – US$29b) (Based on the trailing twelve months to December 2018.)
So, AmerisourceBergen has an ROCE of 16%.
Is AmerisourceBergen’s ROCE Good?
One way to assess ROCE is to compare similar companies. AmerisourceBergen’s ROCE appears to be substantially greater 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 AmerisourceBergen compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for AmerisourceBergen.
Do AmerisourceBergen’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
AmerisourceBergen has total assets of US$39b and current liabilities of US$29b. As a result, its current liabilities are equal to approximately 75% of its total assets. AmerisourceBergen’s current liabilities are fairly high, which increases its ROCE significantly.
Our Take On AmerisourceBergen’s ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. You might be able to find a better buy than AmerisourceBergen. 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).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.