Today we are going to look at FONAR Corporation (NASDAQ:FONR) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 FONAR:
0.14 = US$22m ÷ (US$167m - US$14m) (Based on the trailing twelve months to September 2019.)
So, FONAR has an ROCE of 14%.
Is FONAR's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. FONAR's ROCE appears to be substantially greater than the 8.7% average in the Medical Equipment industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where FONAR sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
FONAR's current ROCE of 14% is lower than its ROCE in the past, which was 23%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how FONAR's past growth compares to other companies.
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 FONAR is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do FONAR's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
FONAR has total liabilities of US$14m and total assets of US$167m. Therefore its current liabilities are equivalent to approximately 8.3% of its total assets. Low current liabilities have only a minimal impact on FONAR's ROCE, making its decent returns more credible.
Our Take On FONAR's ROCE
If it is able to keep this up, FONAR could be attractive. There might be better investments than FONAR 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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