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Why You Should Care About UDG Healthcare plc’s (LON:UDG) Low Return On Capital

Today we’ll evaluate UDG Healthcare plc (LON:UDG) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. 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.

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. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

So, How Do We Calculate ROCE?

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 UDG Healthcare:

0.093 = US$116m ÷ (US$1.5b – US$279m) (Based on the trailing twelve months to September 2018.)

So, UDG Healthcare has an ROCE of 9.3%.

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Is UDG Healthcare’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that UDG Healthcare’s ROCE is fairly close to the Healthcare industry average of 11%. Independently of how UDG Healthcare compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

LSE:UDG Last Perf January 21st 19
LSE:UDG Last Perf January 21st 19

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

UDG Healthcare’s Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.

UDG Healthcare has total assets of US$1.5b and current liabilities of US$279m. As a result, its current liabilities are equal to approximately 18% of its total assets. Low current liabilities are not boosting the ROCE too much.

What We Can Learn From UDG Healthcare’s ROCE

With that in mind, UDG Healthcare’s ROCE appears pretty good. But note: UDG Healthcare 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).

I will like UDG Healthcare better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.