Today we'll evaluate Cardinal Health, Inc. (NYSE:CAH) 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
So, How Do We Calculate ROCE?
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 Cardinal Health:
0.11 = US$1.8b ÷ (US$41b - US$24b) (Based on the trailing twelve months to June 2019.)
Therefore, Cardinal Health has an ROCE of 11%.
Does Cardinal Health Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Cardinal Health's ROCE is around the 11% average reported by the Healthcare industry. Separate from how Cardinal Health stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
We can see that , Cardinal Health currently has an ROCE of 11%, less than the 17% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Cardinal Health's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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.
Do Cardinal Health'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cardinal Health has total liabilities of US$24b and total assets of US$41b. Therefore its current liabilities are equivalent to approximately 59% of its total assets. Cardinal Health's current liabilities are fairly high, making its ROCE look better than otherwise.
Our Take On Cardinal Health's ROCE
Even so, the company reports a mediocre ROCE, and there may be better investments out there. Of course, you might also be able to find a better stock than Cardinal Health. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Cardinal Health better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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