Today we'll evaluate Regis Healthcare Limited (ASX:REG) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to 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.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Regis Healthcare:
0.14 = AU$84m ÷ (AU$1.8b - AU$1.2b) (Based on the trailing twelve months to December 2018.)
Therefore, Regis Healthcare has an ROCE of 14%.
Is Regis Healthcare's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Regis Healthcare's ROCE appears to be substantially greater than the 9.3% average in the Healthcare industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Regis Healthcare compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , Regis Healthcare currently has an ROCE of 14%, less than the 38% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Regis Healthcare'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Regis Healthcare.
How Regis Healthcare's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Regis Healthcare has total assets of AU$1.8b and current liabilities of AU$1.2b. As a result, its current liabilities are equal to approximately 67% of its total assets. Regis Healthcare has a relatively high level of current liabilities, boosting its ROCE meaningfully.
The Bottom Line On Regis Healthcare's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Regis Healthcare 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.