Today we are going to look at Geratherm Medical AG (ETR:GME) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Geratherm Medical:
0.061 = €1.7m ÷ (€33m - €5.4m) (Based on the trailing twelve months to September 2019.)
Therefore, Geratherm Medical has an ROCE of 6.1%.
Does Geratherm Medical Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Geratherm Medical's ROCE is meaningfully below the Medical Equipment industry average of 13%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Geratherm Medical stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
We can see that, Geratherm Medical currently has an ROCE of 6.1%, less than the 12% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Geratherm Medical's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Geratherm Medical? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Geratherm Medical's Current Liabilities And Their Impact On 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Geratherm Medical has total assets of €33m and current liabilities of €5.4m. As a result, its current liabilities are equal to approximately 16% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Geratherm Medical's ROCE
If Geratherm Medical continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Geratherm Medical better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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