Today we'll look at IRadimed Corporation (NASDAQ:IRMD) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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'.
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 IRadimed:
0.13 = US$6.4m ÷ (US$54m - US$5.0m) (Based on the trailing twelve months to March 2019.)
Therefore, IRadimed has an ROCE of 13%.
Is IRadimed's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, IRadimed's ROCE is meaningfully higher than the 10% average in the Medical Equipment industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how IRadimed compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
IRadimed's current ROCE of 13% is lower than 3 years ago, when the company reported a 43% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how IRadimed's ROCE compares to its industry, and you can click it to see more detail on its 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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for IRadimed.
Do IRadimed's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
IRadimed has total assets of US$54m and current liabilities of US$5.0m. As a result, its current liabilities are equal to approximately 9.2% of its total assets. With low current liabilities, IRadimed's decent ROCE looks that much more respectable.
The Bottom Line On IRadimed's ROCE
If IRadimed can continue reinvesting in its business, it could be an attractive prospect. IRadimed 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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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.