Today we'll look at United-Guardian, Inc. (NASDAQ:UG) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 United-Guardian:
0.45 = US$4.9m ÷ (US$13m - US$1.6m) (Based on the trailing twelve months to June 2019.)
So, United-Guardian has an ROCE of 45%.
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 19% average in the Personal Products industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, United-Guardian's ROCE currently appears to be excellent.
We can see that, United-Guardian currently has an ROCE of 45% compared to its ROCE 3 years ago, which was 23%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how United-Guardian's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is United-Guardian? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect United-Guardian's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
United-Guardian has total liabilities of US$1.6m and total assets of US$13m. As a result, its current liabilities are equal to approximately 13% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From United-Guardian's ROCE
Low current liabilities and high ROCE is a good combination, making United-Guardian look quite interesting. United-Guardian shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 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.