Today we'll evaluate Hamilton Thorne Ltd. (CVE:HTL) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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 amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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 Hamilton Thorne:
0.087 = US$3.7m ÷ (US$51m - US$8.9m) (Based on the trailing twelve months to March 2019.)
So, Hamilton Thorne has an ROCE of 8.7%.
Does Hamilton Thorne Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Hamilton Thorne's ROCE is around the 10% average reported by the Medical Equipment industry. Setting aside the industry comparison for now, Hamilton Thorne'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.
We can see that , Hamilton Thorne currently has an ROCE of 8.7%, less than the 22% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Hamilton Thorne's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Hamilton Thorne'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. 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.
Hamilton Thorne has total liabilities of US$8.9m and total assets of US$51m. As a result, its current liabilities are equal to approximately 17% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Hamilton Thorne's ROCE
With that in mind, we're not overly impressed with Hamilton Thorne's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Hamilton Thorne. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 email@example.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.