Today we'll look at National HealthCare Corporation (NYSEMKT:NHC) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
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'.
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 National HealthCare:
0.049 = US$56m ÷ (US$1.3b - US$172m) (Based on the trailing twelve months to June 2019.)
Therefore, National HealthCare has an ROCE of 4.9%.
Is National HealthCare's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see National HealthCare's ROCE is meaningfully below the Healthcare industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how National HealthCare 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, National HealthCare currently has an ROCE of 4.9%, less than the 7.3% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how National HealthCare'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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. If National HealthCare is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do National HealthCare's Current Liabilities Skew 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
National HealthCare has total liabilities of US$172m and total assets of US$1.3b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On National HealthCare's ROCE
While that is good to see, National HealthCare has a low ROCE and does not look attractive in this analysis. Of course, you might also be able to find a better stock than National HealthCare. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.