Today we are going to look at Varex Imaging Corporation (NASDAQ:VREX) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Varex Imaging:
0.054 = US$47m ÷ (US$1.0b - US$175m) (Based on the trailing twelve months to September 2019.)
So, Varex Imaging has an ROCE of 5.4%.
Does Varex Imaging Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Varex Imaging's ROCE appears meaningfully below the 9.4% average reported by the Medical Equipment industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Varex Imaging stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
We can see that, Varex Imaging currently has an ROCE of 5.4%, less than the 20% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Varex Imaging's past growth compares to other companies.
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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Varex Imaging.
How Varex Imaging'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Varex Imaging has total liabilities of US$175m and total assets of US$1.0b. As a result, its current liabilities are equal to approximately 17% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From Varex Imaging's ROCE
Varex Imaging has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Varex Imaging. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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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.