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Examining Varex Imaging Corporation’s (NASDAQ:VREX) Weak Return On Capital Employed

Simply Wall St

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Today we'll evaluate Varex Imaging Corporation (NASDAQ:VREX) 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. Then we'll compare its ROCE 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. 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. 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'.

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 Varex Imaging:

0.069 = US$56m ÷ (US$966m - US$156m) (Based on the trailing twelve months to March 2019.)

Therefore, Varex Imaging has an ROCE of 6.9%.

Check out our latest analysis for Varex Imaging

Does Varex Imaging Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Varex Imaging's ROCE is meaningfully below the Medical Equipment industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Varex Imaging's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Varex Imaging's current ROCE of 6.9% is lower than 3 years ago, when the company reported a 21% ROCE. So investors might consider if it has had issues recently.

NasdaqGS:VREX Past Revenue and Net Income, June 4th 2019
NasdaqGS:VREX Past Revenue and Net Income, June 4th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Varex Imaging.

Varex Imaging's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Varex Imaging has total liabilities of US$156m and total assets of US$966m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From Varex Imaging's ROCE

That said, Varex Imaging's ROCE is mediocre, there may be more attractive investments around. 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.