Today we are going to look at Thomson Medical Group Limited (SGX:A50) to see whether it might be an attractive investment prospect. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 Thomson Medical Group:
0.033 = S$37m ÷ (S$1.5b – S$356m) (Based on the trailing twelve months to December 2018.)
Therefore, Thomson Medical Group has an ROCE of 3.3%.
Does Thomson Medical Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Thomson Medical Group’s ROCE appears meaningfully below the 4.5% average reported by the Healthcare industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Thomson Medical Group’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Thomson Medical Group’s current ROCE of 3.3% is lower than its ROCE in the past, which was 7.2%, 3 years ago. So investors might consider if it has had issues recently.
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 only a point-in-time measure. If Thomson Medical Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Thomson Medical Group’s Current Liabilities Impact 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.
Thomson Medical Group has total liabilities of S$356m and total assets of S$1.5b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Thomson Medical Group’s ROCE
Thomson Medical Group has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Thomson Medical Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.