Today we'll look at Sharps Compliance Corp. (NASDAQ:SMED) and reflect on its potential as an investment. 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, we'll go over how we 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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'.
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 Sharps Compliance:
0.03 = US$1.1m ÷ (US$46m - US$10m) (Based on the trailing twelve months to September 2019.)
Therefore, Sharps Compliance has an ROCE of 3.0%.
Is Sharps Compliance's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Sharps Compliance's ROCE appears to be significantly below the 11% average in the Healthcare industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Sharps Compliance compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. There are potentially more appealing investments elsewhere.
Sharps Compliance reported an ROCE of 3.0% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. The image below shows how Sharps Compliance's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sharps Compliance.
Sharps Compliance's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Sharps Compliance has total liabilities of US$10m and total assets of US$46m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Sharps Compliance's ROCE
While that is good to see, Sharps Compliance has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than Sharps Compliance. 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).
Sharps Compliance is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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