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Examining Tactile Systems Technology, Inc.’s (NASDAQ:TCMD) Weak Return On Capital Employed

Simply Wall St

Today we'll look at Tactile Systems Technology, Inc. (NASDAQ:TCMD) and reflect on its potential as an investment. 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. 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. Ultimately, it is a useful but imperfect metric. 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 Tactile Systems Technology:

0.05 = US$4.8m ÷ (US$114m - US$17m) (Based on the trailing twelve months to March 2019.)

So, Tactile Systems Technology has an ROCE of 5.0%.

See our latest analysis for Tactile Systems Technology

Is Tactile Systems Technology's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Tactile Systems Technology's ROCE appears to be significantly below the 10% average in the Medical Equipment industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Tactile Systems Technology compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.

We can see that , Tactile Systems Technology currently has an ROCE of 5.0%, less than the 12% it reported 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Tactile Systems Technology's past growth compares to other companies.

NasdaqGM:TCMD Past Revenue and Net Income, July 23rd 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. 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 Tactile Systems Technology'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. 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.

Tactile Systems Technology has total assets of US$114m and current liabilities of US$17m. As a result, its current liabilities are equal to approximately 15% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Tactile Systems Technology's ROCE

That's not a bad thing, however Tactile Systems Technology has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.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.