Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we'll look at Chemed Corporation (NYSE:CHE) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Chemed:
0.31 = US$245m ÷ (US$976m - US$192m) (Based on the trailing twelve months to December 2018.)
Therefore, Chemed has an ROCE of 31%.
Is Chemed's ROCE Good?
One way to assess ROCE is to compare similar companies. Chemed's ROCE appears to be substantially greater than the 13% average in the Healthcare industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Chemed's ROCE currently appears to be excellent.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Chemed's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Chemed has total assets of US$976m and current liabilities of US$192m. As a result, its current liabilities are equal to approximately 20% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
The Bottom Line On Chemed's ROCE
With low current liabilities and a high ROCE, Chemed could be worthy of further investigation. There might be better investments than Chemed out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Chemed better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.