Today we’ll evaluate United-Guardian, Inc. (NASDAQ:UG) 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. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. 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 United-Guardian:
0.47 = US$6.1m ÷ (US$14m – US$1.3m) (Based on the trailing twelve months to September 2018.)
Therefore, United-Guardian has an ROCE of 47%.
Does United-Guardian Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. United-Guardian’s ROCE appears to be substantially greater than the 24% average in the Personal Products industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, United-Guardian’s ROCE in absolute terms currently looks quite high.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If United-Guardian is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How United-Guardian’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
United-Guardian has total liabilities of US$1.3m and total assets of US$14m. Therefore its current liabilities are equivalent to approximately 8.8% of its total assets. Minimal current liabilities are not distorting United-Guardian’s impressive ROCE.
Our Take On United-Guardian’s ROCE
This should mark the company as worthy of further investigation. But note: United-Guardian may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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