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Today we’ll evaluate FONAR Corporation (NASDAQ:FONR) to determine whether it could have potential as an investment idea. 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. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 FONAR:
0.19 = US$20m ÷ (US$123m – US$12m) (Based on the trailing twelve months to December 2018.)
So, FONAR has an ROCE of 19%.
Does FONAR Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that FONAR’s ROCE is meaningfully better than the 11% 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.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. You can check if FONAR has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect FONAR’s 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.
FONAR has total liabilities of US$12m and total assets of US$123m. Therefore its current liabilities are equivalent to approximately 9.5% of its total assets. Low current liabilities have only a minimal impact on FONAR’s ROCE, making its decent returns more credible.
What We Can Learn From FONAR’s ROCE
If it is able to keep this up, FONAR could be attractive. Of course you might be able to find a better stock than FONAR. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like FONAR 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 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.