Today we'll evaluate Laboratory Corporation of America Holdings (NYSE:LH) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. 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?
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 Laboratory Corporation of America Holdings:
0.093 = US$1.4b ÷ (US$18b - US$2.6b) (Based on the trailing twelve months to September 2019.)
So, Laboratory Corporation of America Holdings has an ROCE of 9.3%.
Is Laboratory Corporation of America Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Laboratory Corporation of America Holdings's ROCE is fairly close to the Healthcare industry average of 11%. Aside from the industry comparison, Laboratory Corporation of America 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.
You can see in the image below how Laboratory Corporation of America Holdings's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Laboratory Corporation of America Holdings.
Do Laboratory Corporation of America Holdings'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Laboratory Corporation of America Holdings has total liabilities of US$2.6b and total assets of US$18b. As a result, its current liabilities are equal to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Laboratory Corporation of America Holdings's ROCE
With that in mind, we're not overly impressed with Laboratory Corporation of America Holdings's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Laboratory Corporation of America Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.