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Today we'll evaluate Advanced Medical Solutions Group plc (LON:AMS) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Advanced Medical Solutions Group:
0.16 = UK£29m ÷ (UK£195m - UK£19m) (Based on the trailing twelve months to December 2018.)
Therefore, Advanced Medical Solutions Group has an ROCE of 16%.
Is Advanced Medical Solutions Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Advanced Medical Solutions Group's ROCE is meaningfully better than the 11% 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 Advanced Medical Solutions Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how Advanced Medical Solutions Group'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. 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 Advanced Medical Solutions Group.
How Advanced Medical Solutions Group'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 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.
Advanced Medical Solutions Group has total liabilities of UK£19m and total assets of UK£195m. As a result, its current liabilities are equal to approximately 9.5% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Advanced Medical Solutions Group earns a sound return on capital employed.
The Bottom Line On Advanced Medical Solutions Group's ROCE
This is good to see, and while better prospects may exist, Advanced Medical Solutions Group seems worth researching further. Advanced Medical Solutions Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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 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.