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Today we'll evaluate Hill-Rom Holdings, Inc. (NYSE:HRC) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Hill-Rom Holdings:
0.11 = US$390m ÷ (US$4.4b - US$697m) (Based on the trailing twelve months to March 2019.)
So, Hill-Rom Holdings has an ROCE of 11%.
Is Hill-Rom Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Hill-Rom Holdings's ROCE is fairly close to the Medical Equipment industry average of 10%. Setting aside the industry comparison for now, Hill-Rom Holdings'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 , Hill-Rom Holdings currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 5.0%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Hill-Rom Holdings's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hill-Rom Holdings.
What Are Current Liabilities, And How Do They Affect Hill-Rom Holdings's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Hill-Rom Holdings has total assets of US$4.4b and current liabilities of US$697m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Hill-Rom Holdings's ROCE
If Hill-Rom Holdings continues to earn an uninspiring ROCE, there may be better places to invest. 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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. Thank you for reading.