Today we'll look at HMS Holdings Corp. (NASDAQ:HMSY) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 HMS Holdings:
0.094 = US$105m ÷ (US$1.2b - US$76m) (Based on the trailing twelve months to September 2019.)
Therefore, HMS Holdings has an ROCE of 9.4%.
Does HMS Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that HMS Holdings's ROCE is fairly close to the Healthcare Services industry average of 8.0%. Separate from how HMS Holdings 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.
In our analysis, HMS Holdings's ROCE appears to be 9.4%, compared to 3 years ago, when its ROCE was 6.6%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how HMS Holdings's past growth compares to other companies.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect HMS Holdings's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
HMS Holdings has total assets of US$1.2b and current liabilities of US$76m. As a result, its current liabilities are equal to approximately 6.3% of its total assets. With low levels of current liabilities, at least HMS Holdings's mediocre ROCE is not unduly boosted.
What We Can Learn From HMS Holdings's ROCE
Based on this information, HMS Holdings appears to be a mediocre business. You might be able to find a better investment than HMS Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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